Despite the recent market rebound, small- and mid-cap stocks remain largely overvalued and are likely to underperform, warns Sailesh Raj Bhan, CIO of Nippon India Mutual Fund. “Two-thirds of the mid- and small-cap segment remain expensive,” he said, signalling that the correction in these pockets isn’t over, in an exclusive interview with Moneycontrol.
The initial selloff, which hit large caps between October and December, was triggered by FII selling and weak earnings. The correction in mid- and small-caps was more about inflated valuations and earnings disappointments rather than panic-driven exits. “Unreal money flowed into the segment last year, taking stocks into bubble territory, and then there were earnings disappointments. It was not because of panic-driven exits like we saw in large caps, where FIIs sold aggressively,” Bhan explained.
While around 30-40% of mid-caps—roughly 50 out of 150 stocks—are now in a fair price range, large caps have corrected to attractive levels. However, with small caps still stretched, their performance is likely to lag. “Mutual fund flows are still okay, and there is no redemption pressure,” he noted, suggesting that excess valuations will unwind gradually rather than in a sharp collapse. “This adjustment of excess valuation (and correction in stock prices) will be dictated by earnings since mutual fund flows are still okay and there is no redemption pressure,” Bhan said.
When asked where investors should shake off their anchoring bias in valuations due to higher multiples in recent years, he pointed to mid- and small-caps as the most affected. “Fragile businesses with Rs 20 crore operating profit in a quarter were getting Rs 10,000 crore market caps due to liquidity. If fragility persists, we may see some of these lose 50-70% of their market cap. In a tight liquidity environment, these multiples correct sharply,” he warned. “IPOs are another bubble to be cautious about.”
Bhan was also critical of micro-cap stocks that fall outside institutional focus and are primarily held by retail investors. The most brutal corrections so far have happened in small caps that lack institutional attention, with losses of up to 70%. “Individual portfolios have taken a bigger hit than mutual fund portfolios, particularly those in momentum categories, because fundamentals were poor. These are avoidable,” he said.
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