Mid-cap, Small-cap stocks to shine amid improving market sentiment, says Geojit’ Vinod Nair

The Indian stock market underwent a correction phase from 27th September 2024 to 7th April 2025—a span of 192 days, or roughly six and a half months. This consolidation was triggered as India’s total market capitalisation (BSE) surged to ₹4.8 trillion in Sept 2024, pushing the estimated Market Capitalisation to GDP (Mcap/GDP) ratio to 145% based on FY24 nominal GDP, well above the ten-year average of ~90%. 

This rally followed the euphoric third-term victory of the incumbent government in the June 2024 national elections. The political stability and anticipated continuation of reforms spurred heavy buying by domestic institutional investors (DIIs), retail investors, and foreign investors under the “Buy India” strategy. However, the optimism was short-lived as corporate earnings for FY25 sharply declined. Nifty EPS growth was downgraded to just 5% YoY, a significant drop from the 15% forecasted at the fiscal year's start. 

What Derailed Earnings?

Several factors contributed to the earnings slowdown:

• Frequent Elections: Nine state elections and one national election in FY25 led to a significant reduction in both general and capital government spending.
• Weak Demand: Rural and urban consumption was hit by an uneven monsoon, heatwaves, high food inflation, and sluggish wage growth.
• Global Headwinds: Elevated global inflation impacted corporate toplines and EBITDA margins, compressing profit margins.

As a result, the broader Indian market corrected by 20%, making mid- and small-cap stocks more attractive today due to both price and valuation corrections. The Nifty MidSmallcap 400 Index saw an intraday correction of 25% during this period. 

Signs of a Turnaround

The recent Q4 FY25 earnings season has brought encouraging signs. Companies in the Nifty 500 have reported 10.5% earnings growth much better than estimated and marginally better than large caps. This indicates a revival in mid- and small-cap earnings.

Last two quarters showcase those earnings cyclical growth is back. The Wholesale Price Index (WPI), which reflects corporate inflation, dropped to 0.85% in April from an average of 2.25% in Q1 2025. This decline is already translating into improved operational profits, aided by industry-wide repricing strategies and significant ease in inflation. 

Outlook for FY26

The momentum is expected to continue into Q1 FY26 (June quarter), supported by:

• Falling Inflation: Lower input costs are boosting margins.
• Rising Disposable Incomes: Thanks to tax cuts announced in the 2025–26 Budget.
• Increased Government Spending: Post-election fiscal activity is picking up.
• Declining Interest Rates: Lower borrowing costs are expected to spur consumption and investment.

These factors are likely to enhance revenue growth and profitability across sectors. 

A Broader Market Rebound

Market sentiment is also improving due to easing global and domestic risks. A pause in global trade tensions and reduced geopolitical risks in Central Asia, the Gulf, and the India-Pakistan region are lifting investor confidence. The likelihood of a U.S. recession in 2026 is also diminishing, further supporting global market stability.

This improving macro backdrop has sparked a preliminary rally in mid- and small-cap stocks, with renewed interest from both FIIs and retail investors.

Valuation Perspective

Historically, Indian mid-caps have traded at a premium to large caps. In 2024, this premium peaked at 67%, compared to a five-year average of 33%. During the recent correction, the premium dropped significantly and now stands at 36%—a level that suggests strong long-term buying opportunities, especially if earnings continue to rebound in Q1 FY26.

The author, Vinod Nair is Head of Research at Geojit Financial Services.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making investment decisions.