Small-cap index up 13% YTD; do valuations warrant caution? Analysts explain

The inflows into the small-cap mutual funds category have been net positive since April 2024, with July 2026 clocking the highest inflows during this period at ₹7,768 crore

The Nifty Smallcap 100 index has rallied 13 per cent so far in the calendar year 2026 amid sustained investor buying, strong earnings growth expectations and bets on India's underlying growth story. The index hit a fresh 52-week high of 20,025.50 on Friday, climbing 0.92 per cent over its last close of 19,841.45.    Sterlite Technologies emerges as the top index performer with a 502 per cent rise on a year-to-date (Y-T-D) basis (as of August 20), according to data compiled by ACE Equity. Other gainers include IOL Chemicals, Aegis Logistics, Balrampur Chini Mills and Schneider Electric Infrastructure, gaining 71-99 per cent in the said period.

 

 

Analysts believe the bullishness comes down to earnings catching up with expectations. In the recently concluded June quarter, SMID profits accelerated to 28 per cent year-on-year (Y-o-Y), outpacing large-cap profit growth of 21 per cent, as per Nuvama's analysis. This was also the fourth quarter of PAT outperformance for SMIDs.

 

"Smaller companies have posted operating profit growth outpacing large-caps recently, with cleaner balance sheets — net debt-to-equity has fallen sharply, and revenue growth has outrun larger peers," said Ravi Singh, Chief Research Officer from Master Capital Services.  Also Read | Liquidity stress in small-cap funds eases to lowest level since March 2024

 

Furthermore, some of these companies are closest to domestic consumption, manufacturing, and infrastructure themes, driving investor interest, according to Rajesh Singla, Fund Manager & CEO of Alpha AMC.

 

Investors have been consistently pumping inflows into the small-cap funds since nearly 2.5 years and are reaping the benefits of this rise. The inflows into the small-cap mutual funds category have been net positive since April 2024 (or 28 months), with July 2026 clocking the highest inflows during this period at ₹7,768 crore, shows data by primeMFdatabase.com.

 

"The consistent inflows since indicate that investors are positioning for a multi-year opportunity rather than pursuing a rapid rally. The move is more credible than a purely liquidity-driven rally because many of these companies are also experiencing real earnings growth rather than just re-rating," Singla added.

 

Are valuations still justifiable?

According to Singh, trailing PE for the small-cap index sits near 31-33 times, still a premium to large-caps, but the gap is justified by superior earnings growth. "Near previous peaks, some consolidation or mild correction is possible as the index approaches prior highs, but a deep correction appears unlikely given earnings recovery, domestic liquidity, and improving risk-reward," he said.

 

Ambit Capital in a recent note said that small-cap valuations, while not inexpensive in absolute terms, have corrected materially from the elevated levels observed in 2024. "We believe the balance between risk and reward within the Indian small-cap universe has improved materially for the first time since the beginning of CY25," it said.  Also Read | Equity MF inflows down 15 per cent in July despite record smallcap haul

 

The report further highlighted that as of July 2026, 47 per cent of small-cap stocks continued to trade below their 10-year average valuations, compared with 31 per cent of mid-caps and 27 per cent of large caps.

 

Singla believes that even though Broad-based small-cap indices can look stretched, specific companies with strong balance sheets and earnings visibility remain reasonably priced.

 

"Our approach has always been bottom-up stock selection rather than betting on the index, so a correction, if it comes, is something we'd see as an opportunity to add quality names at better prices rather than a red flag," he added.

 

He remains constructive on manufacturing and import-substitution plays that are benefiting from PLI-linked demand, specialty chemicals where Indian companies are gaining share from China, and select financial services names with strong underwriting discipline.

 

Disclaimer: Views and outlook shared belong to the respective brokerages/analysts and are not endorsed by Business Standard. Readers' discretion is advised.