Small-cap, mid-cap indices face worst decline in 2 years; retail investors hit hard

Indian mid-and small-cap stocks are at the forefront of the sustained market sell-off as investors continued to withdraw billions of rupees from these segments, leaving once-favoured pockets of Dalal Street grappling with significant declines.

The market dynamics have worsened due to earnings downgrades, rich valuations, weak sentiment and escalating global trade tensions, resulting in a significant decline in investor confidence and a sharp pullback in small and mid-cap stocks.

The Nifty Small Cap 100 index tumbled nearly 10% in the past week, marking its biggest weekly drop since March 2020, when it fell by 17.71%. In less than two months of the current calendar year, the index has lost 18% of its value and is down 22% from its peak recorded in September.

The last time the index experienced similar selling pressure after reaching its peak was in January 2022. The downturn persisted for the next five months, resulting in a 24% loss.

Similarly, the Nifty Midcap 100 index has dropped almost 13% in 2025 so far and is down 18.17% from its September peak. The index saw a similar selling trend between October 2021 and June 2022, losing 13% of its value.

Both indices began a strong rally in March 2023 and maintained that momentum for 18 months, rising as much as 113% without any significant pullbacks. To sustain this bull phase, companies must report robust earnings to justify their rich valuations.

However, earnings reported by companies in both the mid-and small-cap segments have fallen below street estimates, prompting brokerage firms to trim their target multiples and, consequently, their target prices, adding further pressure on these stocks.

Billions poured in; now retail portfolios feel the pain

The significant drop in stock values is adversely affecting the portfolios of retail investors, who have poured billions into small and mid-cap stocks in recent years through the demat account route, aiming for multibagger returns.

They have also invested heavily through mutual funds, forcing fund managers to deploy excessive capital in this space, which has driven stock valuations to unsustainable levels. For context, the AUM of small-cap funds reached ₹3.30 lakh crore by the end of 2024—six times higher than in January 2020.

Similarly, the AUM of mid-cap funds has surged to ₹4 lakh crore, marking a four-fold increase since January 2020, as per the AMFI data. As of mid-February, mid- and small-cap funds have suffered significant losses, with average declines exceeding 14%.

Despite the sharp correction in small-cap stocks, analysts believe valuations in this space remain stretched. The small-cap index is trading at a forward 12-month price-to-earnings (PE) ratio of 24.5x, well above its 10-year average of 16x.

The mid-cap index’s PE ratio of 35.8x also remains far above its 10-year average of 22.4x. In contrast, the benchmark Nifty 50’s PE ratio stands at 19.9x, slightly below its 10-year average of 20.6x.

Looking ahead, analysts remain cautious about the mid-and small-cap segment, expecting further corrections before a relief rally. Many are also advising investors to shift to large-cap stocks amid the ongoing market downturn.

Disclaimer: The views and recommendations given in this article are those of individual analysts. These do not represent the views of Mint. We advise investors to check with certified experts before taking any investment decisions.