Wealth destroyers: Analysts wary of smallcap stocks on rich valuations

Among individual stocks, Raymond, Ashoka Buildcon, Swan Corp, Himatsingka Seide, and UCO Bank were the biggest wealth destroyers, dropping in the range of 30.5 per cent to 65.78 per cent

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The small-cap universe in the Indian stock market is on course to deliver negative returns for the first time in three years as investors shunned risky bets amid global uncertainty and weak corporate earnings.

 

Thus far in calendar year 2025, the Nifty SmallCap index has declined 6.62 per cent on the National Stock Exchange (NSE) – a sharp contrast from its 24 per cent and 55.6 per cent surge in CY24 and CY23, respectively.

 

By comparison, the Nifty50 index has risen 4.1 per cent so far in 2025, while the Nifty MidCap index has dipped 1.4 per cent. The Nifty index, meanwhile, rallied 8.8 per cent in 2024, and 20 per cent in 2023.

 

Analysts caution that the underperformance of small-cap stocks could continue for the rest of 2025 as valuations remain in “uncomfortable” zone and investors look for earnings safety.

 

"The growing popularity of equity since the Covid-19-led market crash in 2020 resulted in sustained inflows into the small-cap segment over the past few years. This, however, pushed the valuation in small-cap stocks far ahead of their fundamentals," pointed out V K Vijayakumar, chief investment strategist at Geojit Investments Limited. 

Smallcaps

Even now, valuations remain uncomfortable and the segment is prone to further correction, he added.

 

The Nifty SmallCap index trades at a blended 12-month forward price-to-earnings (P/E) valuation multiple of 24.7x as against its five-year and 10-year average of 19.5x and 16.7x, respectively.

 

The Nifty50 index, meanwhile, is at 19.9x P/E, in-line with five-year average of 19.6x.

 

Wealth destroyers

Among individual stocks, Raymond, Ashoka Buildcon, Swan Corp, Himatsingka Seide, Dhani Services, and UCO Bank were the biggest wealth destroyers, dropping in the range of 30.5 per cent to 65.78 per cent this year.

 

Embassy Developments, Inox Wind, ITI, Tata Elxsi, NCC, Rain Industries, Persistent Systems, KEC International, Hindustan Construction Company, Bajaj Electricals, and Delta Corp, meanwhile, crashed between 20 per cent and 30 per cent.

 

"Over FY20-24, the large outperformance of small-cap stocks over large-caps was mainly driven by their much higher earnings growth. That momentum fizzled out in the first quarter of the previous financial year (Q1FY25) due to slowdown in government spending during 2024 general elections, waning domestic consumption growth, impact of US tariffs on exports to US, etc," said Anubhav Mukherjee, Partner at Prescient Capital.

 

Going ahead, Mukherjee said that the small-cap segment will see an upswing only if there is a visible improvement in earnings growth trajectory. Till then, the correction in small-cap stocks may continue, albeit at a decelerated pace.

 

Notably, the small and mid-cap (SMID) sector’s profits decelerated in the June quarter of the current financial year (Q1FY26), to 7-8 per cent year-on-year (Y-o-Y), after accelerating in the previous quarter. SMIDs’ profit margin level, too, was lower than large-caps in Q1.

 

"For FY26, consensus is forecasting a significant bounce in SMIDs’ profitability compared with large-caps. We, however, think they could disappoint as growth is slowing down in a broad-based manner. If SMIDs’ profits continue to disappoint versus large-caps, then this poses large risks to their elevated valuation premiums," noted analysts at Nuvama Institutional Equities in their earnings review report.

 

Invest or stay away?

Analysts believe investors need to cherry pick small-cap stocks as there could be "undiscovered gems" available at reasonable valuations. Investors, however, should keep their return expectations realistic with a long-term horizon, they added.

 

"Given the valuations, market participants should focus on earnings visibility, resilient balance sheets, and exposure to structural growth themes. Disciplined stock selection can uncover opportunities within the broader mid and small-cap universe in sectors like electrical equipments, power generation, and utilities," said Umeshkumar Mehta, CIO, SAMCO Mutual Fund.

 

Anubhav Mukherjee of Prescient Capital, meanwhile, suggests select stock-picking in auto ancillary; power equipment and transmission; transformers, wires & cables, and diesel generators.