The sharp rally in stock prices of small and mid-cap companies, compared to the benchmark index, the Sensex, over the last couple of months, have raised concerns around stretched valuations and building up of a bubble in the segment.

This comes in line with Securities and Exchange Board of India (Sebi) Chairperson Madhabi Puri Buch’s statement in March this year where she clearly spoke about a possible bubble in the small and mid-cap segment, which could potentially hurt retail investors. While her statement led to an immediate correction, stock prices across indices have surged again, and more so in the small and mid-cap segment, indicating that irrational exuberance among investors in risky segments continues despite the regulator’s red flags.

So far in the current financial year, small and mid-cap stocks have witnessed a sharp rally, with the BSE Small cap gaining 12.89 per cent and the BSE Mid cap rising 12.18 per cent. Against this, the Sensex has risen by 4 percent in the period. Market analysts have pointed to this surge as irrational exuberance on account of high liquidity. They have also suggested that investors should move their investments from small and mid-cap segments to large caps.


“We are advising investors to book profit in mid cap and small caps and to invest in large caps,” said CJ George, Founder & Managing Director, Geojit Financial Services.

Meenakshi Dawar, Fund Manager – Equity Investments, Nippon India Mutual Fund, said that investors should not sell their small and mid-cap stocks at this point because there is definitely a growth momentum, but one needs to be cautious as valuation at the entry point. is reasonably high.

Festive offer

She said if a new investor is getting lured by higher returns made in the last 2-3 years and investing in small and mid-cap segments, then it would be a risky strategy.

“A lot of liquidity is chasing these (small and mid-cap) stocks, due to which they have moved up. When investors have made money in a segment, they tend to put fresh money in the same space. That’s normal investor psychology,” according to market analyst Ambareesh Baliga.

On March 11, 2024, the Sebi Chairperson had warned of a potential bubble in small and mid-cap space, which upon bursting, can impact retail investors the most. “Some people call it a bubble; some may call it froth. It may not be appropriate to allow that bubble to keep building because if it keeps building, then when it bursts… by definition bubbles burst, and when they burst, they impact investors adversely, which is not a good thing,” Buch said when asked. about higher valuations of mid and small-cap stocks.
The BSE small and mid-cap indices which were up 5 per cent and 8 per cent respectively prior (between January 1 and March 7) to the regulator’s warning, fell 3 per cent and 1 per cent respectively post (March 7 – March 28) the commentary. In comparison, the Sensex remained stable, declining just 0.63 per cent.

“With a strong catch-up by small and mid-caps in the last couple of months, we still believe the margin of safety in valuations for these segments at current levels has reduced compared to that available in large caps,” said Neeraj Chadawar, Head – Fundamental and Quantitative Research, Axis Securities.

With this view, the broader market may see some time correction in certain pockets in the near term, and flows will likely shift to large caps, he said. In March, Buch also flagged price manipulation in the initial public offering (IPO) of small and medium enterprises (SME) and trading in such stocks.

According to Baliga, in the SME segment, which has seen a large number of IPOs in the last few months, there are concerns about compliance. “There is a possibility of more frauds (in the SME segment) coming into light. If you look at their valuations, most of the stocks have become multi-bagger…not because they were too underpriced…,” Baliga said. Concerns over valuation of PSU stocks

In the last one year, the BSE PSU and BSE CPSE indices have outperformed the Sensex. While the BSE PSU has risen 94.08 per cent, the BSE CPSE increased by 111.67 per cent, against a gain of 21.45 per cent in the Sensex.

Analysts said that around four to five years back the PSU segment was written off, but it has now become the most favored one. They have also raised concerns over higher valuations of these stocks despite low profitability.

Former finance secretary Subhash Chandra Garg said out of the 78 listed PSEs, there are a few companies such as MTNL that have been making big losses, losing turnover and don’t have viable and growing businesses, but their share prices have run up high. “How can any such stocks justify a price rise of 8-10 times in the last four years? Nothing can justify such behavior.
Fundamentals and future business prospects don’t justify this. It has to be either a high dose of irrational exuberance or there might be some plain manipulation, taking advantage of the low floating stocks. That is one set of concerns,” he said.

Market participants said that stock prices of PSUs also soared after Prime Minister Narendra Modi, during a speech in the Parliament in August last year, urged investors to invest in PSUs such as Hindustan Aeronautics Ltd (HAL) and LIC, which have been criticized by the Opposition.

“PM Modi also said on the floor of the Parliament that you buy government shares. It was a nudge and traders just took the cue, and the stock price of PSUs went up,” HDFC Securities Head of Retail Research Deepak Jasani said. He said currently the PSU prices have gone above fair values ​​and are expected to remain there till there is some change in the demand-supply situation.