Smallcaps Deepen Correction as Valuations Reset

During the last 12 months, the BSE SmallCap Index has plummeted close to 7% from the peak it hit in mid 2025, falling to approximately 47800.  Approximately one-half of all small-cap stocks are down more than 10%, indicating the differential amount of stress between them and larger, more stable stocks that make up the large-cap index.

The Nifty SmallCap 100 has a current trading multiple of 28.61X, slightly down from its 2025 highs, while the SmallCap BSE is trading at 24.09X earnings and above 2022 levels.

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The sell-off in early 2026 has highlighted some overvalued metrics in the stocks following more than two years of increasing performance in the small-cap space.

Earnings Momentum Slows

The small-caps have posted disappointing earnings for the current fiscal year, with analysts forecasting further weakened earnings during the upcoming period, following their forecast projection that small-caps can grow more than 20%. The large macroeconomic hurdles caused by budget deficits in the approximately 4% - 4.5% range and moderating government spending will continue to hinder small-caps' growth.

As new-age and defence firms, electronic companies, and contract manufacturers have attracted interest and excitement from the narrative surrounding those stocks rather than from the supporting fundamentals, some of the lowest quality stocks in the market are present in nearly 100 of the 250 small-cap stocks reviewed by analysts.

Due to the reversed flow of liquidity, liquidity continues to be tight.

Fund Actions Signal Cooling

According to the press release dated 3/22/10, ICICI Prudential Mutual Fund is restarting its small-cap fund subscriptions on 23 January after 10 months of being non-existent. This is in response to the continued underperformance and declines in the values of many small caps.

Over 600 small-cap stocks were in double-digit negative territory at the start of the year. And the index hit 8-month lows.

The Year To Date divergence of return on the BSE Small Cap Index shows that of 1213 constituents since the beginning of the year, 1118 are negative, and of these, 49% are down more than 10%.

Valuation Reset Underway

The new cycle of the small-cap market began with a reset of valuations for many of the stocks. Trailing multiples are still above 7-year averages. The starting point differs from previous cycles, as there are many stocks (50-60%) from last calendar year for which they experienced a major decline.