Small and mid-caps defy valuation concerns amid strong inflows

Despite high valuations, small and mid-cap stocks continue to attract robust investor flows. While many caution that the segment may be overheating, fund managers argue that underlying earnings resilience, sectoral tailwinds, and India’s structural growth story are keeping the momentum alive. If you look at MF inflows in June for mid and small caps it stood at small cap Rs 6,484 crore up by 61% from June and mid cap Rs 5,182 crore up by 38% from June compared to large caps inflows in July which stood at Rs 2,125 crore.

The P/E ratio for Nifty Smallcap 250 stood at 31.4 as of August 10,2025 compared to the long-term average of 18.56 in August 2022. Similarly, PE ratio for Nifty Midcap 150 stood at 32.9 as of August 10,2025 compared to the long-term average of 21.59 in August 2022. With respect to long terms returns mid and small caps have given over 28% and 32% in the past 5 years.

Trideep Bhattacharya, President & CIO, Equities, Edelweiss Mutual Fund, attributes the resilience of this segment to sectoral dynamics and earnings strength. “While valuations in mid- and small-cap segments are elevated, they are underpinned by relative earnings resilience. This strength stems from high-growth industries like hospitals, hotels, and EMS, as well as companies gaining market share in consolidating sectors,” he says. Bhattacharya adds that domestic liquidity, driven by rising SIP flows and investor appetite, continues to support the rally.

Varun Goel, Senior Fund Manager at Mirae Asset Investment Managers, agrees that the long-term growth potential remains intact. “Smaller companies are often more agile and better positioned to respond to market disruptions. This adaptability often translates into faster earnings growth, which the market rewards,” says Goel. He adds that while global risks remain, the small-cap earnings cycle is likely to rebound in FY25.

From a sectoral standpoint, fund managers remain constructive on domestic demand-led segments. “We are positive on consumption, especially those benefiting from rural recovery and discretionary spending, and on NBFCs with superior ROE profiles,” Bhattacharya adds.

Goel echoes a similar view. “We remain constructive on banks and NBFCs, especially small finance and regional banks. We also like hospitals and diagnostic companies in the healthcare space and CRAMS businesses riding on global outsourcing tailwinds,” he notes. Mirae MF is bearish on global cyclicals like metals and oil & gas.

At Bajaj Finserv MF, sectoral conviction is visible in real estate, NBFCs, and small banks. “We are bullish on rate-sensitive sectors and building materials like cement. We also see potential in domestic pharma,” says Sorbh Gupta, Head, Equity at Bajaj Finserv MF. However, we remain underweight on IT and export-focused businesses, he adds.

Despite geopolitical risks and macro uncertainties, fund managers believe the impact on mid- and small-caps will be transient. “Such tensions may trigger knee-jerk reactions in risk sentiment, especially in small and mid-cap stocks. But the earnings trajectory is improving, and the economy is on a recovery path,” Gupta explains.

Mohit Bhatia, CEO, Bank of India Mutual Fund, takes a structural view of India’s mid- and small-cap appeal. “Structural reforms, demographics, and infrastructure investments are transforming the operating environment for smaller businesses. Many mid-sized firms now have distinctive models and scalable opportunities,” he says. Bhatia adds that emerging sectors like asset management, digital insurance, and electronics manufacturing largely represented in the mid-cap space are attracting investor interest.

From a positioning standpoint, BOI MF remains overweight on capital goods, power, chemicals, consumer discretionary and selective financials. “We are cautious on IT, autos, exports, and oil & gas, where the medium-term outlook remains unclear,” Bhatia adds.

Fund managers agree that while volatility may persist in the short term, the structural story for India’s small and mid-cap space remains intact. “Short-term noise aside, these segments offer a very good opportunity to capitalise on India’s economic and market growth dynamics over the long term,” says Bhatia.