Small-cap Stocks Show Signs of Attractiveness, Study by Bajaj Finserv AMC Suggests

Small-Cap Stocks Continue to Outperform Amid Global Turmoil

The Indian equity market has been facing challenges due to persistent global geopolitical tensions, elevated crude oil prices, concerns over sticky inflation, and higher interest rates, along with sustained foreign institutional investor (FII) outflows. However, small-cap stocks have continued to defy the broader market conditions, delivering impressive returns in recent months.

According to data, the Nifty Smallcap 100 index has surged nearly 9% over the past three months, significantly outperforming the benchmark Nifty 50 index, which has declined more than 5% during the same period. Over a six-month horizon, the small-cap index has gained over 3%, while delivering a return of 2.9% over one year. In comparison, the Nifty 50 has fallen 8.8% in six months and declined 3.8% over the past year.

A recent study by Bajaj Finserv AMC suggests that small-cap stocks may be nearing an attractive entry point, supported by improving fundamentals, the prospect of an earnings recovery, more reasonable valuations following the recent correction, and historically strong rebound trends. The study highlights the structural transformation in the small-cap universe, with companies increasingly funding expansion through internal cash flows rather than borrowing.

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Key Improvements in Small-Cap Universe

The study shows that aggregate capex in the small-cap segment increased from ₹2.2 lakh crore during FY19-FY22 to nearly ₹3.4 lakh crore during FY23-FY26. Moreover, net debt-to-equity levels declined sharply from 0.52x in FY19 to near-zero levels in FY26. The return on equity (ROE) of small-cap space improved from 9% to 12% during the same period, reflecting stronger financial discipline and sustainable business models.

DIIs Increase Exposure to Small-Cap Segment

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The study also highlights the gradual increase in exposure of Domestic Institutional Investors (DIIs) to the small-cap segment, primarily through Systematic Investment Plans (SIPs). This trend is encouraging as SIP-driven flows tend to be more stable and long-term in nature, which could help reduce volatility in the small-cap space over time. At the same time, retail ownership has moderated slightly, which may reduce excessive speculation.

Valuations Supportive

The fund house highlights that recent market corrections have created opportunities for valuations supported by earnings growth and contextual factors. Nearly 50% of small-cap stocks are trading below their 10-year average valuations, one of the highest such readings in recent years. The study notes that this broad-based correction has helped clear overvaluations from the market and created selective opportunities in fundamentally strong businesses.

Historical Trend of Small-Cap Stocks

The study further observes that small-cap stocks have historically outperformed during recovery phases following downturns. During the post-COVID recovery cycle between March 2020 and January 2022, the Nifty Small-cap Index rebounded 247% compared to 138% for the Nifty 50, highlighting the segment's potential for sharper recoveries over long-term market cycles.