The Nifty Smallcap 100 index plunged 532 points, or 4.1 per cent, to close at 12,450, while the Nifty Midcap 100 index dropped 1,274 points, or 3.1 per cent, to 40,170.3. This was the worst single-day decline for both the indices since December 23, 2022. A day earlier both the indices logged fresh new highs, having rebounded over 40 per cent each from this year’s lows.
The sharp selloff shaved off Rs 5 trillion in market value of companies from beyond the top 50 universe. These companies account for less than half of the total market capitalisation. The top 50 stocks lost only Rs 60,000 crore in market capitalisation in Tuesday trade. The data point highlights the risks of investing in smaller companies—where the rise can be meteoric but the fall too can be steep.
Shares of public sector undertakings (PSUs)—which have been on the tear lately—were among the top losers. Market players said the fall was on the back of profit-taking after a sharp upward move this year. Rumours that a top foreign fund liquidated large positions also weighed on sentiment.
“We do not see many fundamental reasons for the meteoric rise in the stock prices of many mid-cap and small-cap stocks in the past few months. The fundamentals of most sectors have not changed much. However, market sentiment is quite exuberant,” said a note by Kotak Institutional Equities (KIE) a day earlier.
“We see risks of lower profitability and lower valuation multiples due to weakening business models,” the note added.
The sharp rally in this space has lured many new and existing retail investors into investing in these companies. In August, 3.1 million new demat accounts were opened—most since January 2022.
“In the last 12 months, 28 million new investors have come to the market. Many are unaware of the nuances. The meltdown is likely to continue because there is no liquidity. Even if overall market capitalisation declines by 1 per cent, the small caps are going to suffer badly. Immediate buying support will come only for index and large-cap stocks from institutional investors,” said Chokkalingam G, Founder of Equinomics.
Many new small-cap favourites of institutional and retail investors have risen in the last three to six months, with the expectation of a decent investment cycle. However, analysts expressed concerns about the quality of many of these stocks, given their weak execution and governance track records.
“In addition, many of these sectors fall in the B2G (business-to-government) or B2B categories, which raises issues around execution and profitability. We believe that market expectations for both revenues and profitability may be too optimistic across these sectors,” said the note by KIE.
“It’s a recurring trend. Whenever small caps do well, the expectations become too optimistic. And one has serious doubts about whether some will turn around because of their huge debts,” said Chokkalingam.
Going forward, analysts said a certain amount of correction is due as the small caps have seen a one-sided rally since March this year.
“A correction was due and is likely to be broad-based, swift, and healthy. This year is likely to be a good year. We might see a 10-12 per cent correction, and once the excess froth is absorbed, then we will resume our upward journey,” said Jimeet Modi, chief executive officer of Samco Securities.