Smallcap, Midcap profit growth falters for second straight quarter; valuations still elevated despite market correction

Small-cap and mid-cap (SMID) companies, which outpaced large caps in profitability for most of FY24, have now entered their second consecutive quarter of underperformance, according to Nuvama Institutional Equities. The brokerage attributes this weakness to a domestic slowdown, to which SMIDs are more vulnerable.

Excluding the Banking, Financial Services, and Insurance (BFSI) sector, SMID profit growth has sharply declined and is now contracting on a year-on-year (YoY) basis. In contrast, large caps have demonstrated relatively stable earnings. The only bright spot for SMIDs remains BFSI, where banks continue to post strong profit growth.

Margin Pressures and Cyclical Weakness

Smallcap stocks and Midcap stocks also lag behind large caps in terms of profit margins, which tend to be more cyclical. While post-COVID tailwinds helped SMIDs achieve greater margin expansion than large caps, these benefits are now reversing, according to Nuvama Equities. Analysts caution that SMID margins could see further downside, given their greater sensitivity to economic cycles.

Consensus estimates currently forecast SMID profits to outperform in FY26. However, Nuvama Equities warns that fading margin advantages and weak top-line growth put this projection at risk. If SMID earnings continue to disappoint, their valuation premiums over large caps could come under significant pressure.

Smallcap, Midcap Stocks Valuations Remain Expensive

Despite a recent correction in the broader markets, valuations of mid and small-cap stocks remain expensive compared to historical levels and relative to the Nifty 50. According to MOFSL, the Nifty 50 is currently trading at a 12-month forward price-to-earnings (P/E) ratio of 19.3x, below its long-period average (LPA) of 20.5x.

Over the past six months, the Nifty Smallcap 100 index has declined 17.7%, while the Nifty Midcap 100 has fallen 11.8% . This is against the benchmark Nifty 50's drop of 6.7% during the same period.

MOFSL remains tilted toward large caps, with a 76% allocation in its model portfolio. The brokerage maintains an overweight stance on Consumption, BFSI, IT, Industrials, Healthcare, and Real Estate while remaining underweight on Oil & Gas, Cement, Automobiles, and Metals.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.