Rs 8 lakh crore boom takes smallcap stocks to new highs. Did you sell too soon?

Just when retail investors were losing patience with veterans warning that a bull market correction can throw the baby out with the bath water, smallcap stocks have bounced back with a bang amid expectations of earnings growth having bottomed out in Q2, signs of recovery in government's capex cycle in H2 and BJP's victory in Maharashtra elections.

Since November 22, when the market started factoring in BJP's electoral success, the BSE Smallcap index comprising 945 stocks has rallied 11% to a fresh record high of 57,799 on Wednesday.

The total market capitalization of all smallcaps in the index has rallied by Rs 7,77,491 crore during the period with stocks like Ashapura Minechem, 63 Moons, Oriental Rail, Lincoln Pharmaceuticals, Greaves Cotton, EKI Energy, Swan Energy, Nelco, Shivalik Rasayan and HEG jumping anywhere between 40-86%.

Even as the headline indices Sensex and Nifty are 6% away from their peaks touched in September-end, the sharp recovery in smaller stocks shows that animal spirits are back on the Street.

"The smallcap rally is attributed to robust gains in various sectors, including textiles, IT, pharmaceuticals, and infrastructure. Smallcaps have better sectoral diversity compared to largecaps, which has insulated them from some of the volatility caused by foreign portfolio investor (FPI) outflows. This diversity is crucial for sustaining momentum and attracting domestic investors," Rajesh Sinha, Fundamental Analyst at Bonanza Portfolio, told ET Markets.


The advance-decline ratio in the smallcap segment also indicates a positive investor sentiment, with a significantly higher number of stocks advancing than declining.

Since April 2023, the Nifty Smallcap 100 index has nearly doubled in value. According to the latest data from AMFI, smallcap funds saw the highest inflows last month compared to the past 13 months. Year-to-date, the total inflows in the smallcap category have been close to Rs 30,000 crore and the category as a whole has grown by over 46%.

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“With so much euphoria around small-cap stocks, it's easy for investors to succumb to recency bias and overlook the risks involved. While the smallcap index has performed well in the past couple of years, if you zoom out, you’ll see that from January 2018 to March 2023, Nifty Smallcap 100 was essentially flat. This means that for over five years, investors who entered before 2018 saw no returns on their capital, and now, in just 1.5 years, the category has delivered nearly 100% returns,” points out Vivek Sharma, Investment Head at Estee Advisors.

Market insiders are finding strong signs of capex recovery in 2HFY25, with many projects now being bid out and execution likely to accelerate.

"Defence, Roadways, and Communication could show a sharp sequential jump, whereas Railways is, surprisingly, ahead of the full-year run-rate and may not show strong 2H seasonality. YoY growth for ROY25 will look more impressive because of front-loaded expenditure in FY24 (52% of budgeted capex in FY24YTD)," said Emkay Global's Seshadri Sen.

On the earnings front too, analysts expect some growth pickup in H2FY25 vis a vis H1FY25 as H1 had an impact from monsoons and elections due to labour availability, lower government spend etc.

"Companies reliant on government spending saw subdued earnings due to a 15% decline in central government capex in 1HFY25, compared to 43% growth in 1HFY24. This slowdown is expected to be temporary, with normalization likely in 2HFY25. Urban demand is softening, and rural demand is seeing some green shoots. We do expect recovery in government capex during the second half of this fiscal year, which should benefit companies and sectors linked to this theme," said Franklin Templeton’s Venkatesh Sanjeevi.

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As far as smallcaps are concerned, experts are once again warning retail investors to not get overenthusiastic and buy only on the basis of fundamentals.

“Corporate governance failures are very common in these segments, and low liquidity can make it hard for investors to exit certain stocks. While nobody has the crystal ball that can predict how long the rally in small-cap and micro-cap stocks will last, investors should at least not underestimate the risks and take a holistic picture before making the investment decision,” Sharma said.

(Data: Ritesh Presswala)

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)