Indian small-cap stocks have witnessed a remarkable surge driven by foreign portfolio investors (FPIs) in the wake of Q1 financial results. Year-to-date, the BSE Smallcap index has soared by an impressive 30 percent, outpacing the gains of the BSE Sensex, which has risen by only 8 percent during the same period. Notably, approximately 75 stocks within the BSE Smallcap index have registered astounding gains of over 100 percent in the current year, with Jai Balaji Industries, sporting a market capitalization of approximately ₹4,675 crore as of September 4, leading the pack with a staggering 451 percent surge.
What’s Driving the Small-Cap Surge?
The surge in small-cap stocks can be attributed to robust buying activity by foreign portfolio investors (FPIs) following the release of Q1 financial results. This positive momentum is expected to persist as the valuations of several of these companies remain relatively lower compared to their mid-cap and large-cap counterparts.
Deepak Jasani, Head of Retail Research at HDFC Securities, notes, “Small-caps have been performing exceptionally well as FPI flows continue to be largely positive. High-net-worth individuals (HNIs) have also been increasingly investing in these stocks in recent weeks. Furthermore, the Q1 results of these companies met or exceeded expectations, as business volumes shifted from unorganized to organized sectors. The fact that we haven’t witnessed any significant market sell-off lasting more than a few days suggests that investors are in no hurry to book profits and tend to overlook temporary overvaluations.”
Anita Gandhi, Director at Arihant Capital, adds that small-cap stocks often outpace GDP growth in a growing economy, making them appealing to investors seeking higher returns. She also attributes the growing interest in equities, especially within the small-cap segment, to sustained foreign fund inflows and anticipation of a favorable earnings quarter, which have rekindled investor confidence and positive sentiment.
Are Small-Caps in a Bubble?
While the small-cap rally has been impressive, some experts caution that the segment may be at risk of a correction after its rapid ascent in recent months.
Vinod Nair, Head of Research at Geojit Financial Services, acknowledges that mid and small-caps still offer attractive valuations compared to historical trends, but he advises caution given the broader market consolidation. He explains, “Our view is that India is increasingly becoming a stock-to-sector play. While mid and small-caps have shown strong short-term performance, sustaining this in the near term could pose challenges.”
G. Chokkalingam of Equinomics Research Private Limited believes that the small and mid-cap segment of the domestic market faces significant short-term risks. These include overvaluation of many small-cap stocks, liquidity tightening in the secondary markets due to a surge in IPOs, rights issues, and equity sales by private equity funds, foreign institutional investors, and promoters, alongside rising global oil prices, potential uncertainty from upcoming state elections, increases in crop prices, and a subpar monsoon.
Chokkalingam notes, “Liquidity is exiting secondary stock markets, and we believe these resources are unlikely to return in the short term. We hold a highly positive outlook for the medium to long-term market performance, particularly post the 2024 General Elections. However, we are cautious about the small and mid-cap segment in the short term.”
Trading in Smaller Companies: Expert Advice
Given the potential for overvaluation, experts offer guidance on how to approach trading in smaller companies.
Chokkalingam recommends maintaining a cash allocation of 5 to 10 percent within the equity asset class, allocating 5 percent to gold ETFs, and favoring large and large midcaps (40 to 50 percent based on risk profiles) while exiting overvalued individual stocks.
Anita Gandhi underscores the need for caution and thorough research before venturing into small-cap stocks, citing their inherent higher risk and volatility. Diversification and a long-term investment approach are suggested to mitigate risks.
Trivesh D, COO of Tradejini, advises exercising caution and making informed investment decisions rather than succumbing to market trends. Focusing on companies with strong fundamentals and positive cash flows is crucial.
Shrey Jain, Founder and CEO of SAS Online, suggests that investors with a horizon exceeding three years should consider staying invested in the small-cap equity market, while short-term investors should contemplate booking profits in segments with stretched valuations.
Kaushik Dani, Fund Manager – PMS, Abans Investment Managers, emphasizes a bottom-up approach to stock picking based on individual merits and a disciplined investment approach.
claimer: The views and recommendations provided in this article are those of individual analysts and broking companies, and do not necessarily reflect the views of Mint. Investors are advised to seek advice from certified experts before making investment decisions.
