Smallcaps outperform Nifty, Sensex, analysts advise caution

Experts recommend investors to exercise caution and avoid investing in companies with lower-quality metrics such as balance sheet strength, cash flow robustness, or management credibility.

The benchmark indices ended firmly higher on April 1 after touching fresh record highs intraday. The rally was led by index heavyweight financials and IT stocks, along with metal and realty scrips.

Smallcaps and midcaps outperformed with BSE Smallcap and Midcap index rallying up to 3 percent. Firm global markets and a moderation in a key US inflation reading also aided the positive sentiment.

The Sensex ended 363.20 points or 0.49 percent higher at 74,014.55, and the Nifty was rose 135.10 points or 0.61 percent to 22,462.00. The overall market capitalisation (mcap) of BSE-listed firms rose to nearly Rs 393.2 lakh crore, making investors richer by nearly Rs 6.2 lakh crore in a single day.

The Nifty Smallcap 100 and Nifty Midcap 100 indices have recorded positive gains in the month of April in 11 out of the last 14 years. Even in terms of average returns, April emerges as the most lucrative month for both these indices.

The positive movement can be attributed to market anticipating better-than-expected earnings growth, and taking fresh positions after profit-booking in March.

Also Read | Gainers and Losers: 10 stocks that moved the most on April 1

Cautionary flags for Smallcap investors

The rally in smallcaps this time around, however, should be examined carefully according to analysts since midcap and smallcap indices have seen a sharp rally of up to 75 percent in the last one year. According to Varun Lohchab, head of institutional research at HDFC Securities, while midcaps appear only moderately overvalued, certain segments of smallcap universe are definitely trading ahead of their fundamentals.

Hence, "it won’t be a surprise, if we witness another wave of correction to bring smallcaps to a much reasonable level," he told Moneycontrol.

The rally this time around, however, should be examined carefully, since midcap and smallcap indices have seen a sharp rally of up to 75 percent in the last year, analysts said.

According to Varun Lohchab, head of institutional research at HDFC Securities, while midcaps appear only moderately overvalued, certain segments of smallcap universe are trading ahead of their fundamentals.

Hence, "It won’t be a surprise, if we witness another wave of correction to bring smallcaps to a much reasonable level," he told Moneycontrol.

Experts advise investors to exercise caution and avoid investing in companies with lower-quality metrics such as balance sheet strength, cash flow robustness, or management credibility. Investing in stocks without strong earnings support could be risky due to high market valuations, potential reduced liquidity from FIIs and increased regulatory scrutiny, they said.

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Recently, there have been reports of mutual funds introducing restrictions on redemptions from the smallcaps schemes in response to the " frothy" valuation in the segment and the concerns expressed by the SEBI.

According to VK Vijayakumar, Chief Investment Strategist, Geojit Financial Services, the consequence of this action would be higher flows of funds into the largecaps, which, in turn, can lift the largecaps. "So, watch out for largecaps in automobiles, capital goods, financials and select pharma which are likely to post good Q4 numbers," he said.

Disclaimer: The views and investment tips expressed by investment experts on Moneycontrol.com are their own and not those of the website or its management. Moneycontrol.com advises users to check with certified experts before taking any investment decisions.