Indian small-caps stocks in a bear market, with analysts

By Bharath Rajeswaran and Vivek Kumar M

(Reuters) – Indian small-cap shares have tumbled more than 20% from their record closing high, confirming they are in a bear market, with analysts expecting a further 5% drop by the end of March.

A perfect storm of weaker economic growth, foreign outflows and fears of slower inflows into domestic funds have led the decline in these stocks where valuations had stretched beyond fundamentals, analysts said.

On Friday, the small-cap 100 index ended 21.6% below its record closing high hit on December 11 — moving past the 20% threshold that is widely considered to confirm an underlying security is in a bear market.

As of the day’s close, the mid-cap 100 index was 18.4% lower than its closing high on September 24.

Despite the declines, both indexes are trading at higher valuations than their long-term averages.

The small-cap index is trading at a forward 12-month price-to-earnings (PE) ratio of 24.5x, well above its 10-year average of 16x, according to brokerage Motilal Oswal Financial Services.

The mid-cap index’s PE ratio of 35.8x is also handily above its 10-year average of 22.4x.

In contrast, the benchmark Nifty 50’s PE ratio of 19.9x is just below its 10-year average of 20.6x.

“The valuations are sky-high. To justify the valuations in small- and mid-caps by earnings is almost impossible,” said Mayuresh Joshi, head of equity research India at William O’Neil and Company.

These elevated valuations are due to a rally over the past few years, powered mainly by retail and mutual fund inflows.

The small-cap index has surged 93% between 2023 and 2024, while the mid-cap index has rocketed 82%, with both dwarfing the 31% rise in the Nifty 50.

“Clearly, investors will shift to large-caps from small- and mid-caps in the next few months as they came into these segments in the first place chasing returns,” said Nitin Bhasin, head of institutional equities at Ambit Capital.

“Now that the returns are diminishing, they are likely to choose large-caps where at least capital erosion is unlikely.”

A lackluster set of earnings in the past two quarter do not justify the rich valuations of small- and mid-cap stocks, and this could intensify the pressure on these segments, analysts said.

They expect a further 5% drop before the decline bottoms out.

(Reporting by Bharath Rajeswaran and Vivek Kumar M in Bengaluru, additional reporting by Indranil Sarkar)