Select pockets in SMID space still offer long-term opportunities, say experts

2023 saw Sensex and Nifty advancing by 19 percent and 20 percent, and the Midcap and SmallCap indices climbing 46 percent and 47.5 percent, respectively.

Certain pockets in the small- and mid-cap segment offer better opportunity than large-caps even though as a segment, small- and mid-cap have seen significant earnings slowdown. A section of leading market participants justify investing in the segment based on long-term opportunities, especially in a rapidly growing economy like India.

Market participants say that sectors like real estate, capital goods, public sector undertakings (PSUs), industrials, and defence, which historically had limited representation in large-cap indices could see heightened activity.

Antique Stock Broking highlights that while certain segments of mid-cap stocks may appear overvalued, they consistently offer compelling long-term investment opportunities in a dynamic economy like India.

The brokerage firm anticipates robust growth in the mid-cap segment over the next 2–3 years, fuelled by a recovery in capital expenditure, easing inflation, and declining interest rates. Earnings per share (EPS) growth is projected at 15% for the Nifty-50, outpaced by 25% for the Nifty Midcap 100 and 20% for the Nifty Smallcap 100 during the same period, it says.

Motilal Oswal Securities also echoes this view but adds a caveat while advising a balanced approach. “While growth prospects in these sectors remain strong, the rich valuations of mid- and small-cap stocks call for caution, particularly in cases where stock prices have significantly outpaced earnings growth,” it said in a recent note.

In 2024, the benchmarks Sensex and Nifty recorded gains of over 8 percent each, while the BSE Midcap and BSE SmallCap indices surged by 26 percent and 29 percent, respectively. In comparison, 2023 saw Sensex and Nifty advancing by 19 percent and 20 percent, and the Midcap and SmallCap indices climbing 46 percent and 47.5 percent, respectively.

Ritesh Jain, Founder of Pinetree Macro, believes select mid- and small-cap stocks will outperform large-cap indices for the third consecutive year. He highlights structural shifts in the Indian economy, noting that tomorrow’s winners are often absent from large-cap benchmarks.

According to experts, key drivers for the growth include strong economic momentum, increased government spending on infrastructure, healthy order books, and an improved earnings outlook across these sectors. The 12-month forward price-to-earnings (P/E) ratio for mid-caps currently stands at 31x, a 56% premium to the Nifty-50. For small-caps, the P/E is at 23.2x, a 17% premium.

Anirudh Garg- Partner and Fund Manager at Invasset PMS said they encourage avoiding biases, particularly the assumption that wealth creation is limited to mid and small-cap companies. While these segments offer significant potential, the focus should remain on identifying businesses -- irrespective of market capitalisation -- with solid fundamentals, competent management, and a clear competitive edge. Adopting a long-term perspective, coupled with diligent research, will help investors capitalise on opportunities within these dynamic segments, he says.

For 2025, the strategy for mid and small-cap segments will revolve around a disciplined and growth-oriented approach. Investors should focus on identifying sectors and companies that demonstrate clear earnings visibility and resilience over the next two to three years. The emphasis should be on sustainable business models with competitive advantages that enable them to navigate market challenges effectively, Garg added.

Few analysts anticipate that small and mid-cap earnings will grow at around 1.5 times the rate of their large-cap counterparts over the next two years. However, it is important to note that the same level of price performance may not be directly mirrored by this accelerated earnings growth.

“As we continue our search for companies where the trinity of growth, quality, and valuation aligns favourably, the pool of opportunities that meet these criteria is steadily shrinking. Despite this, we are finding opportunities which have reasonable valuations and companies that offer growth potential,” says Sahil Shah, Managing Director, and Chief Investment Officer, Equirus.