Small-caps steal a march over large-caps, look primed for outperformance

Stocks in the small-cap universe have started to outperform large-caps. On Wednesday, the National Stock Exchange Nifty Smallcap 100 rose 0.53 per cent, even as the Nifty fell 0.6 per cent. This was just a persistence of a trend seen over the past month when the Nifty Smallcap 100 gained 6.1 per cent and the Nifty 2.7 per cent.

After underperforming the Nifty for 18 months, small-caps look primed for outperformance, observe analysts.

While the Nifty50 and the Nifty Midcap 100 have come close to hitting new lifetime highs, the Nifty Smallcap 100 is still some distance away, signalling more value. The index hit a record high of 12,047 in January 2022 and is currently trading at 9,938 — nearly 18 per cent lower.

The Nifty Smallcap 100 has lagged the Nifty by 20 per cent in 18 months. Analysts say a mean revision is playing out where small-caps could make up for 18 months of underperformance. A note by Nuvama states that the small- and mid-cap indices look favourable on several parameters.

“An analysis of the earnings upgrades versus downgrades shows that downgrades are slowing. The small- and mid-cap valuation premium/discount is back to the historical mean after being higher around December 2021. On balance, versus six months ago, indicators suggest that the time to get more constructive on small- and mid-caps is nearing,” reads the note.

When it comes to earnings upgrades, the note adds, this is a middle stage where the downgrades continue but slow down before eventually reaching a point over the next year when a trend of earnings upgrades starts again.

Moreover, the upmove in the equity markets will shift towards small-caps, the brokerage predicts.

“From the end of March to date, we have seen a good move in the index. At the beginning of the upmove, you have the large-cap moving first and then the mid- and small-caps,” says Ambareesh Baliga, an independent equity analyst.

Baliga adds that the markets are at a point where they would go into consolidation.

“Maybe a sideways correction is when we see individual stocks moving. Those individual stocks would be small- and mid-caps. In the next two-three months, the Nifty may not go anywhere, but we will see action in mid- and small-caps,” says Baliga.

Chokkalingam G, founder, Equinomics Research & Advisory, says the sectoral diversity and valuations make the small-cap pack attractive at present.

“The small-cap index is not heavy on a particular sector. They are present in many unique sectors where large-caps are not present. Many stocks in the small-cap index are trading with single-digit price-to-earnings multiples. Moreover, the gush of new investors is continuing, and the moment they are confident of an upcycle in the markets, they will gravitate towards small-caps. For the next six months, I am bullish,” says Chokkalingam.

The only headwind against a revival of small-caps is a broad-based correction due to some extraneous factor.

“The only headwind could be a huge deal in monsoons. Otherwise, all factors are supportive of a rise. Earnings have been better than what the markets were expecting. And inputs are likely to go down, and oil prices are low and steady,” adds Baliga.