Small-cap stocks have continued to outperform large-cap peers despite weak broader market conditions amid persistent global geopolitical tensions stemming from the US-Iran conflict, elevated crude oil prices, concerns over sticky inflation and higher interest rates, and sustained foreign institutional investor (FII) outflows from the Indian equity market.
The 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 has fallen 8.8% in six months and declined 3.8% over the past year.
Against this backdrop of relative strength, a study by Bajaj Finserv AMC indicates 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.
Improving Fundamentals
The small-cap universe has undergone a significant structural transformation in recent years. According to the Bajaj Finserv AMC report, are increasingly funding expansion through internal cash flows rather than borrowing, resulting in healthier balance sheets and improved profitability metrics.
Aggregate capex in the segment increased from approximately ₹2.2 lakh crore during FY19–FY22 to nearly ₹3.4 lakh crore during FY23–FY26, while net debt-to-equity levels declined sharply from 0.52x in FY19 to near-zero levels in FY26, the report showed.
The return on equity (ROE) of smallcap space improved from 9% to 12% during the same period, reflecting stronger financial discipline and sustainable business models.
DII Raising Stake
The study also highlighted the gradual increase in exposure of Domestic Institutional Investors (DIIs) to the small-cap segment, primarily through .
“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,” said the report.
Valuations Supportive
The fund house highlights that recent market corrections have also created opportunities for valuations supported by earnings growth and contextual factors, with nearly 50% of smallcap stocks trading below their 10-year average valuations, one of the highest such readings in recent years.
The study also notes that this broad-based correction has helped clear overvaluations from the market and created selective opportunities in fundamentally strong businesses.
The AMC further observes that smallcaps 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.
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