The Indian stock market recently witnessed a significant shift as several midcap and smallcap stocks, including prominent PSU names, hit their 52-week lows. Companies like Bandhan Bank, UCO Bank, Natco Pharma, Ircon International Ltd, IRCTC, ACC, BEML, and Titagarh Rail Systems experienced notable declines, signaling potential concerns for investors. This downturn, largely driven by disappointing Q3 earnings growth, has raised questions about the valuation premiums these stocks enjoy over large-cap counterparts.

Q3 Earnings Disappointment: A Key Factor

The earnings performance of small and midcap (SMID) stocks in Q3 has been underwhelming, marking the second consecutive quarter of disappointing results. Analysts note that SMID profits are now trailing behind large caps, primarily because domestic growth, to which SMIDs are more exposed, has slowed significantly in FY25. Nuvama research suggests that without a substantial easing in policy, the ongoing SMID bear market may persist.

Key Insights:

• Profits of SMIDs are now undershooting large-cap profits.
• Domestic growth has decelerated, impacting SMIDs more than large caps.
• A policy shift might be necessary to reverse the negative trend.

Performance Metrics: SMID vs. Large Caps

When excluding the BFSI sector, the profit growth for SMIDs has shown a sharp decline. In fact, Nifty Smallcap 100 and Nifty Midcap 100 have reported sales growth of 11% and 8%, respectively, compared to Nifty's 6% rise. Despite similar top-line growth post-COVID, SMIDs have seen higher profit margin improvements than large caps. However, with these tailwinds reversing, SMIDs now face the risk of sharper margin contractions.

Valuation Concerns Amid Market Volatility

The valuation metrics for SMID stocks have also taken a hit. The Nifty MidSmallcap400 Index now trades at a price-to-earnings (PE) ratio of 30.1 times based on trailing 12-month earnings. Since September 2024, the median PE has dropped by 8.8%, from 30 times to 27.4 times, reflecting the broader market's concerns.

Current Valuation Snapshot:

• Nifty's 1-year forward PE: 19.3x
• SMID Index trailing PE: 30.1x
• BSE500 stocks under 30x PE: 39.4% (up from 30.4%)

Retail Investor Sentiment and Future Outlook

Retail investors, known for driving demand in the midcap and smallcap segments, might be reassessing their strategies. Kotak's recent analysis indicates that many retail investors entered the market at higher levels, which could be overstating the actual returns seen in headline indices. Furthermore, factors like taxes and trading costs are eroding investor returns, creating an atmosphere of caution.

Market Projections:

• Emkay Global predicts continued pressure in Q4 but expects recovery in Q1FY26.
• Nuvama highlights risks to SMID profits, especially if margin tailwinds continue to fade.

Conclusion:

The recent performance of midcap and smallcap stocks serves as a reminder of the cyclical nature of the market. As earnings growth stagnates and valuations become less attractive, investors must exercise caution and conduct thorough research before making investment decisions. The upcoming quarters will be crucial, especially if global conditions stabilize and earnings begin to recover. MBC Trading Platform will continue to provide timely insights to help investors navigate these market dynamics with confidence.

Disclaimer: This article is for informational purposes only and should not be construed as investment advice. Please consult a financial advisor Mbc trading Platform  before making any investment decisions.