India's equity market is experiencing a fundamental transformation, with mid-cap stocks accounting for 20.3% of total listed market capitalisation and small-caps contributing 21.1% as of May 2026, according to a recent report by Motilal Oswal Financial Services. In contrast, large-cap stocks have fallen to a record low of 58.7% of total market capitalisation. However, latest analysis by Mint reveals that despite recovering from March lows, small- and mid-cap stocks continue to trade at elevated valuations, indicating that the correction has not eliminated froth entirely. The West Asia war-led correction reduced some excesses, but valuations have turned expensive again as the recovery since March has pushed several stocks back into expensive zones. As per Mint, investors face a problem they haven't experienced in a long time: two consecutive years without meaningful equity returns, with most Indian equity investors belonging to the post-covid generation who have never experienced a prolonged bear market.
The outperformance has been particularly pronounced in specific sectors, with metals, capital goods, and healthcare sectors emerging as top performers on a month-on-month basis, as reported by Motilal Oswal. In year-to-date performance for calendar year 2026, SMIDs have continued to outperform large-caps, supported by strong gains in capital goods, metals, defence, and oil & gas stocks. However, technology has remained the key laggard, reflecting persistent weakness in IT stocks. Within the Nifty index, only 24 constituents ended higher in May, with Adani Enterprises, Tata Motors and Grasim Industries among the top gainers, while ONGC, SBI and ITC were among major laggards. According to Mint, over the past year, domestic investors have directed most of their money into mid-cap and small-cap companies, largely ignoring large-caps because they do not find the growth prospects exciting enough to meet their return expectations.
Market valuations reveal a stark divergence across sectors, with private banks, consumer, technology and retail sectors trading at discounts of 35%, 10%, 26% and 32% respectively to their 10-year averages on a 12-month forward price-to-earnings basis, according to the Motilal Oswal report. In contrast, sectors such as automobiles, capital goods, non-lending NBFCs, healthcare and chemicals are trading at premiums, with capital goods commanding a steep 56% premium over its long-period average. On an EV/EBITDA basis, real estate remains the only sector trading at a discount, while metals, oil & gas, utilities and cement are at or above their historical valuation levels. As per Mint, large-cap valuations are falling steadily because companies cannot provide the market with adequate growth visibility, FIIs have sold relentlessly, and markets are punishing companies at the slightest sign of adverse news. The valuation gap between large-caps and the rest of the market—particularly mid-cap and small-cap companies—continues to widen as relentless FII selling in large-cap stocks creates an inverted market structure.
Small-cap stocks have experienced the most pronounced valuation corrections, with 36.2% of BSE SmallCap companies trading above 40 times earnings at the September 2024 peak, which fell sharply to 21.6% by March-end before rising again to 27.6% as of June 5. The improvement is more visible in reasonable valuation zones, with the share of small-cap companies trading between 10 and 25 times earnings rising from 19.3% at the peak to 28.4% by March-end, before easing slightly to 27.1% by June 5. As per Mint, the inverted market structure is likely to worsen because investor behaviour tends to be slow to change, with any further decline in headline indices only amplifying this trend. This shows that while the correction reduced some froth, parts of the market have turned expensive again, even as sentiment remains weak.
Market experts suggest that the current correction offers strategic opportunities for selective investing, with Mint analysis indicating that conviction should increasingly shift towards safer equity positions as the return to large-caps now appears both inevitable and necessary. Prasenjit Paul from 129 Wealth notes that "the current market weakness is offering valuation comfort and building a base for the next structural bull run." He recommends that investors with a one to two-year horizon should use market weakness to gradually increase allocation in selective stocks that have shown resilience, emphasizing that "action during market weakness decides the quantum of wealth one can generate in the upcoming bull run." Shyam Sekhar from ithought Financial Consulting LLP suggests that investors must seek defence in valuations while preparing for growth to return, noting that while mid-cap and small-cap stocks can deliver superior returns during periods of rapid economic expansion, it is equally important to seek the relative safety of large-caps when growth slows. The analysis suggests that investors should focus on companies that have held up well despite broader market weakness rather than simply buying the most corrected stocks, as the market remains forward-looking despite current negative macro headwinds including elevated oil prices, inflation worries, and Middle East conflict.
