Smallcap Stocks Face Selloff as Valuation Concerns Rise
Thursday saw sharp fall in smallcap stocks on theIndian stock market as 55 stocks reached their 52-week lows during ongoing market corrections. The selloff occurs amid anxieties about high PEs and decelerating earnings growth headwinds to market expectations. Although largecap stocks have been relatively stable because of the several months of foreign institutional disinvestment, domestic institutional inflows into sectoral and thematic funds have driven up the valuations of smallcaps, which are thus more prone to sharp reversal.
Market gurus have warned overvaluation of small and midcap stocks, such as ICICI Prudential’s S Naren. Naren has recommended investors short the stocks and to cut losses, due to structurally unsound price levels. This trend is also observed in the performances of the BSE Smallcap index that has fallen by 16% till date in 2025 as against a 3% decline in the Sensex. The losses measured over the three- and six-month time periods reflect eroding investor sentiment and anxieties about a retail liquidation.
Indicators Point to Prolonged Pressure
Elara Securities has cautioned that the ongoing downturn may result in a change in market structure, and smallcaps in particular may experience sustained selling pressure. Analysts have pointed out leading indicators by way of, e.g., the degree to which stocks stop trading above their 200 day moving averages and the lagging of equal-weighted portfolio performance. These trends indicate that the supply-demand relationship in the market could be persistent with a seller-lead imbalance for a substantial time.
Market data supports these concerns, as one-third of BSE Smallcap index constituents have revisited their one-year lows in February alone. Even after the recent markdown, smallcap stocks are still trading at a premium valuation, with the BSE Smallcap index priced at a multiple-of-earnings of 28 times the trailing 12-month earnings per share (EPS), compared to the Sensex multiple-of-earnings of 21.43. It implies that additional refinements are warranted prior to alignment of valuations with the market fundamentals.
Major Losers in Smallcap Stocks
Some of the smallcap stocks have experienced huge fallouts, wiping out large amounts of investor wealth. Companies such as Kamdhenu Ventures Ltd, Dish TV India Ltd, Sterling and Wilson Renewable Energy Ltd, Honasa Consumer Ltd, Salasar Techno Engineering Ltd, Vakrangee Ltd, Subex Ltd, Hardwyn India Ltd, and Gensol Engineering Ltd have plummeted 75-80% from their 52-week highs.
Also, stocks such as Ideaforge Technology Ltd, Ahluwalia Contracts (India) Ltd, Easy Trip Planners Ltd, Yatra Online Ltd, MMTC Ltd, Rajesh Exports Ltd, Data Patterns (India) Ltd, and Juniper Hotels Ltd have dropped more than 50%. Other notable losers include Sanghi Industries Ltd, Ircon International Ltd, New Delhi Television Ltd, Voltamp Transformers Ltd, Tanla Platforms Ltd, PNC Infratech Ltd, DB Corp Ltd, and Butterfly Gandhimathi Appliances Ltd, all of which have lost nearly half of their market value.
Smallcap Overvaluation and Retail Investor Concerns
The explosive growth of the smallcap segment has become a topic of concern regarding sustainability. The Smallcap 250 index, representing 9.1% of full market capitalization in 2024, shot up to *20% on dealflow and high prices. Nevertheless, this expansion gave smallcap stocks much higher volatility (e.g., observation today in the correction phase).
Kotak Institutional Equities has pointed out that retail investors may have entered at very high levels which in turn may have resulted in lower real returns compared to the rest of the smallcap indices. The brokerage firm has questioned whether retail investors might soon reach a breaking point, prompting further selloffs.
While there is still ongoing correction, the data of the mutual fund industry shows that retail investors are still buying smallcap funds at least in January. According to Juzer Gabajiwala (Director and Company Secretary at Ventura Securities), sectoral and thematic funds continue to see high levels of new money inflows, they are also signaling an increased risk appetite of investors.
Lessons from Past Corrections
Historical trends suggest that mutual fund inflows into smallcaps have remained strong even during past corrections. Analysts at Elara Securities observed that, small and midcap (SMID) correction period,Inflows into smallcap funds still happened,despite mean stock decline levels of 50%. The present market cycle seems to be approaching the same scenario with the continued entry of mutual fund at very high price levels after the steep drop of prices of the respective assets.
However, not all market experts are bearish on smallcaps. Pawan Bharaddia, Co-founder of Equitree Capital, has noted that smallcap corrections usually take 8-12 weeks before stabilizing. He thinks that midcap stocks in India are now at the tail-end of this correction and their valuations are becoming more attractive for buy-and-hold investors over the long term.
Conclusion
The recent sharp decline in smallcap stock represents a cautioning phenomenon about the potential risk of overvaluation and retail driven bubble. Although experts disagree about whether this correction is going to be a correction, now is the time to take a cautious approach. Market participants should closely watch valuation movements and liquidity arrival to ride out the volatility in the the smallcap market.
Disclaimer:
The information provided in this article is for informational purposes only and does not constitute financial, investment, or trading advice. Readers are advised to conduct their own research or consult with a financial expert before making any investment decisions. YPBB News is not responsible for any financial losses incurred based on the information provided.
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