Small and Mid-Cap Stocks Face Liquidity Crisis Amid Earnings Volatility

Market Correction in Mid- and Small-Cap Stocks

Key Findings

• Within the Nifty 50 stocks, 16 are trading 15-33% below their 52-week highs, whereas the broader Nifty 500 shows deeper corrections, with 34 stocks down 40-75% and another 203 stocks trading 20-39% below.
• The disproportionate correction in the SMID segment is driven by liquidity rather than earnings growth momentum, according to Vinay Jaising, chief investment officer at ASK Private Wealth.

Liquidity Impact

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• Foreign institutional investors own a smaller percentage in SMID stocks, with around 18% ownership in NSE 500, 16% in mid-caps, and 14% in small caps.
• The outflow of almost $24 billion from January 2025 has increased pressure on small caps, which have lower liquidity compared to mid-caps and large caps.

Earnings Growth

• Despite earnings growth returning in the December quarter, the drag on SMIDs is likely to continue, with NSE 500 witnessing a sales, Ebitda, and profit after tax growth of almost 10%, 13%, and 11%, respectively.
• PAT growth for large cap, mid-cap, and small cap was 12%, 16%, and 25%, respectively, excluding oil and gas space.

Valuations

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• The Nifty 50 is currently trading at 17.56 times one-year forward earnings, a sharp discount to its five-year average of 23.8 times and just 2.7% below its lifetime high.
• The Nifty Midcap 100 trades at 22.89 times FY27 earnings versus a long-term average of 35.5 times, while the Nifty Smallcap 250 stands at 20.74 times compared with its historical average of 28.1 times.

Underperformance

• Small- and micro-cap stocks had a dream run during and after Covid, with the Nifty 250 Small cap index up over 550% between March 2020 and September 2024, while microcap stocks witnessed an even sharper run-up.
• The tailwinds that drove earnings growth and valuation re-rating in recent years have turned into headwinds, including geopolitical tensions, trade barriers, higher rates, and moderated nominal GDP growth.