Low-quality smallcap stocks may get hit hard, warns Kotak

The recent sharp fall in smallcap stocks has put retail investors at greater risk given their high stakes in the pocket. Kotak said it still is unsure if the correction marks a reversal of the market to fundamentals and numbers from sentiment and narratives. But if it is the first case, many low-quality stocks may still have a long way to fall, it warned.

Kalyan Jewellers, MRPL, Cochin Shipyard, NBCC, Birlasoft, Cyient, Zensar Technologies, IRB Infra and KEI Industries are some smallcaps trading at expensive valuations on consensus estimates. Others included Global Health, Jyothy Labs, Glenmark Pharma, RITES and CESC.   These are the smallcap companies, which are covered by at least five analysts. (Source: Kotak Institutional Equities)

FPIs owned 23.3 per cent, 15.5 per cent and 12.1 per cent of NSE 100 index, NSE Midcap 100 index and NSE Smallcap 100 index while MFs owned 9.4 per cent, 10.4 per cent and 8.3 per cent of NSE 100 index, NSE Midcap 100 index and NSE Smallcap 100 index as of December 31, 2023

Retail investors, on the other hand, have generally favoured small cap stocks. Their holding in the NSE 100 index, NSE Midcap 100 index and NSE Smallcap 100 index stood at 7.9 per cent, 9.5 per cent and 15.4 per cent in December 2023 versus 7.5 per cent, 8.4 per cent and 12.5 per cent in March 2019.

"It would appear that retail investors have taken a more positive view on small-cap stocks and a more active part in the rally in smallcap stocks and are thus, more exposed to the ongoing correction," Kotak said.

Suzlon Energy, BSE, MCX and HUDCO were among top contributor of the rally seen in the smallcap index in the last one six months.

The domestic brokerage finds valuations of the majority of the midcap and smallcap stocks to be quite expensive, especially in the context of their business models as well as their own history. The recent rally

"The recent correction in broader markets is quite small in the context of the large returns of the past year. The Nifty Midcap 100 Index and the Nifty Smallcap 100 Index are down 5 per cent and 10 per cent in the past one month but they are still up 53 per cent and 58 per cent, respectively, in the past one year," it said.

A total of 61 per cent of mid cap and 63 per cent of small cap stocks have given more than 30 per cent return in the past year.