India's rapidly expanding equity market is prompting a comprehensive reassessment of stock classifications, with market participants increasingly questioning the relevance of the current system that classifies the top 100 listed companies as large-caps, the next 150 as mid-caps, and all companies beyond the 250th rank as small-caps. According to The Hindu BusinessLine, Sanjeev Prasad, Co-Head and Managing Director at Kotak Institutional Equities, argues that 'How can only 100 stocks be classified as large-caps when market capitalisation has increased so much? There has to be a threshold defined by size rather than the number of stocks'. The debate extends beyond terminology, with industry executives warning that outdated classifications may be funnelling money into a narrow set of stocks while leaving a substantial segment of listed companies outside the institutional investment universe. Recent market volatility, including Tuesday's decline where Sensex fell 0.28% to 74,646.73 and Nifty 50 dropped 0.23% to 23,359.85, highlights the challenges of using traditional classifications for meaningful investment analysis.
According to a report by Kotak Institutional Equities, the Nifty Midcap 150 Index comprises 150 stocks based on full-float market capitalisation, with stocks ranking between 101 and 250 by market cap classified as midcap. As reported by Business Standard, KIE analysts highlight that the index's 'mechanical' nature has resulted in considerable churn in constituents, with only 46 stocks remaining consistently in the index from 2021-22 through H1-FY27, while 275 unique stocks were part of the index during FY22-26. The restrictive nature means one or a few sectors can have outsized influence on overall earnings growth and valuations, with several stocks from popular sectors entering simultaneously while sectors out of favour may become under-represented. Recent market movements show this volatility, with IT stocks declining up to 4% and Nifty IT index falling 1.32% on Tuesday, while Nifty Realty gained 0.55% as the top sectoral performer.
The index's performance over FY22-26 reveals significant concentration risks, with around 27 stocks accounting for over 50% of the index's performance in any half-year period during H1FY22-H2FY26, as reported by Kotak Institutional Equities. According to the analysis, 41 erstwhile mid-cap stocks graduated to the Nifty 50 or Nifty Next 50 indices, while 129 erstwhile mid-cap stocks either moved to the Nifty Smallcap 250 Index or were no longer part of any index. The Kotak Institutional Equities report estimates that a hypothetical unchanged Nifty Midcap 150 portfolio from April 2021 would have delivered a return of 68%, compared with the reported 116% gain generated by the actual index after periodic reconstitution. Prasad notes that 'Out of the 150 stocks in the mid-cap index, only 46 are common over the last five years. So what exactly are we comparing?' Recent market performance reflects these challenges, with top midcap performers including JSW Infrastructure Ltd. (5.38%) and Coal India (2%+) while broader market sentiment remains mixed amid sectoral divergence.
As noted by Kotak Institutional Equities analysts, the frequent changes make it difficult to use the index for meaningful comparisons of future earnings growth with historical earnings growth, or future valuation multiples with historical multiples. According to Sanjeev Prasad, the index's restrictive nature means it has limited utility for meaningful historical comparisons and analysis due to its mechanical and restrictive nature. The report emphasizes that several stocks that were among the top contributors were no longer part of the index after some time, further limiting the index's historical relevance for investment analysis. Prasad argues that frequent changes in index constituents, often driven by market narratives and sectoral themes rather than fundamentals, create misleading benchmarks and contribute to what he describes as a 'survivorship bias' effect. Recent market volatility, including FIIs selling equities worth ₹576.20 crore on Monday and Brent crude oil rising 0.8% to $101.1 per barrel, highlights how these factors can significantly impact midcap performance and historical analysis.
Market veteran Arun Kejriwal has advocated for significant expansion of India's classification system, calling for two new categories: micro-cap and mini-micro-cap to complement the current three-tier structure. As reported by The Hindu BusinessLine, Kejriwal argues that 'If companies with issue sizes of Rs 150-200 crore are listing on the main board, how can everything beyond the top 250 stocks simply be called small-cap?' He believes investors and mutual funds should have the flexibility to allocate capital across a much wider spectrum of listed companies, suggesting 'Instead of having just three categories, bring in five or six'. Mahavir Lunawat, Managing Director of Pantomath Group, warns that companies with market capitalisations of around ₹40,000 crore are today categorised as small-caps simply because they fall outside the top 250 stocks by market value, highlighting how rigid classifications are concentrating institutional money into a limited universe despite significant market expansion. Recent market movements, with Nifty Midcap 100 gaining 0.06% while Smallcap 100 was marginally down 0.1%, demonstrate the need for more nuanced classification systems that can better reflect market dynamics and investment opportunities across different company sizes.
