Small-cap stocks delivered exceptional performance in the first quarter of FY27, with the Nifty Smallcap-250 reporting 35% year-on-year growth in earnings, leading the Nifty-500's overall earnings performance. According to The Economic Times, this strong earnings growth has been driven primarily by the Financials and Oil & Gas sectors, with NBFC lenders, private banks, NBFC non-lenders and chemicals also contributing significantly. FY27 profit growth is estimated at 16% for Nifty 100, 20% for midcaps and 34% for smallcaps, according to Venugopal Manghat, chief investment officer-equity at HSBC Mutual Fund, providing room for mid and smallcaps to catch up with earnings growth.
The small-cap rally extends beyond headline indices, with broader market participation showing remarkable strength. According to The Economic Times, the average advance-to-decline ratio stood at 1.07 in August, its highest level in four months and above 1 for five consecutive months - the longest winning streak in more than two and a half years. This indicates that more stocks are rising than declining, with buying spread across a larger number of securities. Mid- and small-cap schemes received ₹13,960 crore in August, representing 56% of total equity flows, compared to 40% in the previous month. In contrast, large-cap funds saw outflows of ₹1,322 crore, marking their first outflow in 30 months, demonstrating clear investor preference for smaller companies.
The performance divergence has been dramatic since April, with small-caps significantly outpacing large-caps. As reported by The Economic Times, since April, the Nifty Smallcap 100 has jumped 31% while the Nifty Midcap 100 has gained 22%, compared to the Sensex and Nifty's gains of 8% and 9% respectively. The Nifty 500 has gained 15% during the same period. Manish Bhandari, CEO and Portfolio Manager at Vallum Capital, notes that June-quarter profit growth for Nifty 50 companies reached 18%, the highest in 10 quarters, with 19 sectors beating earnings expectations. The Nifty Smallcap 250 is trading around 5 points above its five-year average price-to-earnings (PE) multiple of 27.0x, while the Nifty 50 is trading around 2 points below its five-year average PE of 22.1x.
New analysis by DSP Asset Managers reveals that while small-cap companies have delivered impressive aggregate earnings growth, much of this outperformance is driven by a small number of extreme performers. According to DSP's analysis, smallcap profit after tax (PAT) compounded at 36.8% annually between FY17 and FY26, compared with 21.2% for midcaps and 14% for largecaps. However, when excluding the best and worst 2% of companies by aggregate profits, smallcap PAT CAGR falls to 24.8%, while midcap PAT CAGR drops to 17.1% from 21.2%. The report attributes substantial portion of earnings outperformance to margin expansion rather than superior revenue growth, with smallcap PAT margins increasing from just 1.3% in FY17 to 8.4% on a trailing 12-month basis through June 2026, while midcap margins rose from 6% to 12.8% over the same period.
Despite strong headline performance, market breadth analysis reveals concerning trends in small-cap participation. According to The Economic Times, only 37.2% of stocks in the Nifty Smallcap 250 have outperformed the benchmark in 2026, the lowest proportion in eight years, even as the index delivered the strongest return among large, mid and smallcap benchmarks. While 24% of smallcap stocks have gained more than 25% this year, most constituents have failed to beat the index, raising execution risk for investors chasing recent performance. In contrast, about 65% of Nifty 100 constituents are outperforming their benchmark, the highest level in eight years, indicating that weakness among largecaps is concentrated in a relatively small group of stocks. Pawan Bharaddia from Equitree Capital Advisors notes that dispersion within market cap segments is now greater than the differences between them, making broad allocation calls less useful.
