Mid-cap and small-cap stocks, which had been outperforming the larger benchmark indices this year, experienced significant declines of up to 4 per cent on September 12, 2023, raising concerns about overvaluation.
The BSE Small-Cap Index saw a 4.02 per cent drop, while the Mid-Cap Index fell 2.96 per cent. This is after the Mid-Cap Index surged by over 50 per cent, and the Small-Cap Index rose by more than 30 per cent in the current calendar year.
Notably, the fall came after Kotak Institutional Equities on September 12, 2023 stopped recommending small-caps and mid-caps.
“We see limited point in trying to find fundamental reasons behind the steep increase in stock prices of several mid-cap and small-cap stocks. The primary driver of the rally appears to be the irrational exuberance among investors, with high return expectations (and purchase decisions) being driven by the high returns of the past few months,” the report said.
Highlighting the high return expectations, the report said that in the last year, 6.4 million new mutual fund folios were opened in mid-cap and small-cap schemes, which was a 34 per cent increase from the previous year.
Sandeep Jain, market analyst and director of Tradeswift, a stockbroking firm, suggests that investors should consider “buying on dips,” but only those companies with strong fundamentals.
Buying on dips is a strategy that involves purchasing stocks that have recently decreased in price, with the expectation of a rebound. Jain believes these stocks could start bottoming out by tomorrow, and recover soon.
“This could be a good time to buy these stocks at lower prices. They might start recovering as early as tomorrow. These stocks should find support around their previous high levels, specifically around 12,047 for the NSE Small Cap 100 Index. Consider buying these stocks in a staggered manner gradually, when they dip in price. The valuations of these companies are reasonable, and many of the stocks that dipped in price have strong fundamentals,” Jain adds.
Jain cautions that investors should only look for companies with reasonable valuations and strong fundamentals in order to minimise risks.
Avinash Luthria, a Sebi Registered Investment Advisor (RIA) and Founder of Fiduciaries, also suggests investing with caution.
He says Sebi’s definition of small-cap includes a wide range of companies staring from the 251st, ranked by market capitalisation. “Sebi’s official definition has only large-cap, mid-cap and small-cap. So, a company ranked 251 is a small-cap and a company ranked 501 is also a small-cap as is a company ranked 2,000. Within these companies, 501 onwards could be called micro-caps,” Luthria adds.
Luthria cautions against investing heavily in micro-cap companies (those ranked 501st and beyond) due to their weak disclosure practices. “Retail investors should only allocate less than 4 per cent of their portfolio to them, which is their market weight (their market capitalisation in listed stocks),” he says.
With the recent drop in mid-cap and small-cap stocks, experts are only advising to consider companies with strong fundamentals.