Expert highlights huge valuation gap between small-caps and Nifty 50

Small-cap stocks are trading at nearly double the valuation of the Nifty 50, a rare market dichotomy, says an expert. This gap is attributed to a focus on growth stocks, with sustained FII inflows seen as crucial for narrowing the difference.

Unusual Valuation Gap in Indian Market

Small-cap stocks are trading at nearly twice the valuation of the Nifty 50, highlighting a sharp gap across market segments, while a sustained return of foreign institutional investors (FIIs) could be important for narrowing the valuation difference, VK Vijayakumar, Chief Investment Strategist of Geojit Investments, said in an interview with ANI.

Vijayakumar said the Indian market is currently seeing an unusual difference in valuations between large-cap, mid-cap and small-cap stocks. According to him, the Nifty 50 is trading at a trailing price-to-earnings (PE) multiple of 19.7, compared with 29.9 for the Nifty Midcap 100 and around 34.4 for the Nifty 100 Smallcap index.

"This is a very important characteristic of the market in India now. There is a huge dichotomy in valuations," Vijayakumar said. He added, "These kinds of variations or dichotomy in valuations are very rare. Normally, in a stable normal market, large caps will have a premium over mid-caps and mid-caps will have a premium over small caps. But now it is just the reverse,"

Focus on Growth Stocks Driving Valuations

Vijayakumar attributed the difference partly to investors' strong focus on growth stocks. He said investors are currently more focused on growth stocks than value stocks, which has helped companies with longer growth prospects command elevated valuations. He cited digital and new-age platform companies as examples, saying their high valuations are partly supported by expectations of a long growth path over the coming years.

"So this is the reason why we have this gap in valuations between large caps on the one side and the mid and small caps on the other side," he said.

Future Trends and Market Correction

Vijayakumar also said the current valuation difference may not persist indefinitely. He referred to the market concept of "reversion to mean", or a movement back towards average valuations.

"A trend going forward, a likely trend going forward would be the valuations of large caps. At least certain segments of large caps, like for example, the banking majors, the financial majors, then the capital goods majors, and some diversified companies, they are growing and therefore they deserve a much higher valuation," he said. He added that some of the elevated valuations in the mid- and small-cap segments could cool down as the gap narrows.

Role of Foreign Investor Flows

According to Vijayakumar, foreign investor flows will be an important factor in this process. He said FIIs sold around USD 19 billion worth of Indian equities last year. Although they turned buyers in July and August this year, they again became sellers in September.

"If the growth momentum in the Indian economy and the prospects of the earnings growth remain good, and they are likely to remain good, and because of the decline in crude prices, hopefully, and the decline in bond yields, FIIs can turn buyers," he said.

Supportive Economic Outlook

Looking ahead, Vijayakumar said India's domestic economic outlook remains supportive, with GDP growth of around 7 per cent in financial year 2027 achievable and Nifty earnings growth of 12-14 per cent possible. (ANI)

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