Smallcaps face EPS downgrade risk; largecaps seen safer bets amid earnings cuts

The latest CLSA report on Indian equities highlights growing risks for small-cap stocks within the NSE 500, with analysts continuing to favour large caps for stability as the market faces significant earnings estimate downgrades. "We see high EPS downgrade risks in small caps and continue to favour large caps."

A detailed Q3FY26 review of 419 companies from the NSE500 index with adequate analyst coverage presents a mixed picture. Sales growth hit a 10-quarter high of 12.9 per cent YoY, with discretionary, industrials, real estate, healthcare and materials showing clear traction, said CLSA.

Ex-energy growth was an even stronger 15.9 per cent YoY, underscoring a broad-based demand recovery supported by GST rate rationalisation and a robust festive season. Most sectors, except telecom and healthcare, saw an acceleration in revenue growth, the brokerage firm noted.

However, profit growth softened to 9 per cent YoY, breaking a four-quarter streak of double-digit growth, as one-off provisions linked to labour code changes weighed on profitability. Telecom, utilities, IT and healthcare were the main drags, while energy, industrials and consumer discretionary drove growth, it said.

Earnings breadth narrowed sharply, with nearly 80 per cent of incremental profit growth attributed to oil & gas and financials. Excluding these two sectors, PAT grew just 0.6 per cent YoY, a sharp drop from 19.5 per cent YoY growth in 2QFY26, said the report.

Across market caps, mid-caps were again the core driver, with PAT growth of 19.6 per cent YoY, marking a sixth straight quarter of leadership. Large caps lagged at 6.6 per cent YoY, while small-cap earnings slowed to 12.9per cent YoY from 18.9 per cent in Q2FY26, it said.

Upgrades were led by materials, energy, IT, and banks, while real estate, healthcare and industrials faced downgrades. Large caps saw the strongest upgrades, with consensus raising FY27/FY28 earnings by 0.6 per cent/0.9 per cent. Mid-cap earnings were trimmed 0.3 per cent for FY27 but upgraded by 0.5 per cent for FY28. Small caps, for the third straight quarter, faced sharp cuts of 3.9 per cent/3.1 per cent for FY 27/28, said the global broker.

Despite these forecasts, 62 per cent of small caps are expected to deliver a 20 per cent earnings CAGR over the next two years, but only 39 per cent actually achieved this in the past four quarters, said CLSA's report. "The gap between forward expectations and trailing delivery is much smaller for mid-caps and large caps, suggesting small caps may have the highest downgrade risk."

CLSA concludes that the market remains under pressure as expectations outpace delivery, with elevated valuations limiting further upsides. "We see a clear burden of expectation along with elevated valuation limiting the scope of large upsides. Limiting EPS downgrades will be very important."