Covid-era bargains in largecaps, bull market valuations in smallcaps: Where is the real opportunity in stocks?

India’s stock market has split into two sharply divergent camps as largecap stocks have been battered into valuations last seen around the Covid crash, while smallcaps continue to trade at multiples that imply strong earnings growth ahead.

The Nifty has fallen 14% so far in 2026, even as the Nifty Midcap 150 has declined just 2%, the Nifty Smallcap 100 has gained 8% and the Nifty Microcap 250 has climbed 15%. Foreign investors have sold a record ₹2.8 lakh crore of Indian equities this year, intensifying the pressure on large, liquid stocks.

The result is a market where the weakest recent performers may now offer the strongest risk-reward, while segments that have held up may leave little room for disappointment.


DSP Mutual Fund described the setup as “the great dichotomy” of the market where small and midcaps are trading at “full-blown bull market multiples”, while several largecaps are near decade-low valuations.

“The risk-return trade-off is in favour of large caps,” said Anish Tawakley, chief investment officer at DSP Mutual Fund. “As a general rule one should not chase performance. It is better to invest in segments that have lagged in the past few years than in segments that have done well.”

Also Read | Nifty valuations near post-Covid lows. Alchemy Capital’s Alok Agarwal explains what investors should buy now

Largecaps offer the valuation cushion

The Nifty 50 is trading at 16.9 times one-year forward earnings, according to Nomura. That is below its 17-22 times post-pandemic range and slightly below its pre-pandemic average. The brokerage noted that the index last traded at this valuation during the pandemic in June 2020.

Nomura has also cut its target multiple for the Nifty50 to 17 times from 18.5 times, citing higher yields, and set a March 2027 target of 24,000. It said investors should adopt a bottom-up, value-conscious approach and avoid chasing market narratives.

Alchemy Capital Management’s Deputy CIO Alok Agarwal said the Nifty’s one-year forward price-to-earnings multiple has fallen to 17.4 times in September 2026 from 21.5 times in September 2024. During the same period, the index corrected 11%, while earnings continued to grow, albeit slowly.

“The multiple did the falling,” Agarwal said.

He added that current valuations are close to the lowest levels seen in the post-Covid era. However, he cautioned investors against anchoring to the 11.5 times forward P/E seen during the Covid crash.

“That’s a panic price, not a fair value,” Agarwal said. “What we have now is a reasonable one, which is where long-term returns usually start.”

DSP’s data points to a similar conclusion. The Nifty 50 is trading at 19.26 times trailing earnings and 2.75 times trailing book value, compared with long-term medians of 20.9 times and 3.5 times, respectively. The Nifty 100 is trading at a 12% discount to its five-year median P/E.

Largecaps are also trading at unusually low relative levels against midcaps. The Nifty’s trailing price-to-book valuation relative to midcaps is near an all-time low, while its five-year compound annual return relative to midcaps is close to previous troughs.

Also Read | Nifty 500’s hidden bear market: Half the stocks are down over 30% from highs

High-growth burden of smallcaps

The valuation picture becomes less comfortable further down the market cap curve. Nomura said the Nifty Small Cap index is trading at 23.7 times one-year forward earnings, above its post-pandemic average of 22.9 times and well above the 14-15 times range seen before the pandemic. Its 39.3% premium over the Nifty 50 is the highest in more than a decade.

DSP’s valuation data shows the Nifty Smallcap 250 at 33 times earnings and the Nifty Midcap 150 at 27.6 times earnings. The smallcap index is at the 75th percentile of its five-year valuation history, while midcap valuations are closer to their five-year average but are not cheap.

“SMIDs now need extraordinary fundamentals to sustain extraordinary relative returns,” DSP said. Largecaps, by contrast, need only some normalisation of the unusually wide valuation gap.

The relative outperformance has been significant. Over the past year, smallcaps have outperformed the Sensex by 21.5% and midcaps by 14.1%, according to DSP. Earlier relative peaks in 2007, 2010 and 2017 were followed by meaningful mean reversion. The median subsequent 24-month relative decline was about 30% for smallcaps and 21% for midcaps.

That does not mean a correction must begin immediately. But it does mean that the margin of safety has narrowed.

One of the more unusual features of the current market is that defensive sectors have lost much of their traditional valuation premium over cyclicals.

Private banks, IT and consumer staples now trade at roughly similar forward valuations to cyclical sectors. DSP said the historical premium of defensives over cyclicals, which had been about 70%, has effectively disappeared. The last comparable extreme was around the 2007 capital-expenditure boom.

DSP’s sector analysis identified IT, private banks, FMCG and financial services among the areas where returns have been washed out relative to their own histories. Public sector banks, capital goods, infrastructure, telecom and other cyclical segments, on the other hand, continue to rank above their historical base rates.

Nomura also found that financials, IT services and consumption sectors have de-rated significantly and now trade below pre-pandemic multiples. It remained positive on financials and IT services because of their valuations, while cautioning on consumption.

Where should investors look?

Nomura’s preferred approach is to favour value, remain selective in growth and avoid paying for narratives. Its preferred themes include established exporters, auto components, pharmaceuticals, power equipment, data centres, power infrastructure and AI-led opportunities in IT services.

The brokerage is constructive on auto ancillaries, engineering and manufacturing, pharmaceuticals, financials and IT services. It is cautious on consumption and neutral on commodities.

For investors willing to allocate to midcaps and smallcaps, the message is not to exit the segment wholesale but to be more selective. Tawakley recommended relying on experienced fund managers who understand how to handle portfolios when market cycles turn.

Agarwal said a long-term investor with a horizon of at least seven years and the ability to remain invested through a bear market could consider allocating 35%-50% of an equity portfolio to midcaps and smallcaps. But that allocation should be based on the drawdown an investor can tolerate, not on the return being targeted.

“Smallcap drawdowns have historically been deep and long, sometimes lasting years rather than months,” Agarwal said. “The allocation only works if one is still holding when the recovery comes.”

For now, the market’s risk-reward equation appears to favour largecaps. Small and midcaps may continue to deliver if earnings consistently exceed elevated expectations. But after a period of strong outperformance, the burden of proof has shifted to them.

The opportunity, therefore, may lie less in buying what has recently worked and more in identifying quality businesses where prices have already absorbed years of weak performance, subdued earnings growth and FII selling.

(Disclaimer: This article has been written by Nikhil Agarwal, who is not a SEBI-registered Research Analyst or an Investment Adviser. Nikhil Agarwal and his/her ‘relative(s)’ (as defined under Section 2(77) of the Companies Act, 2013) do not hold any financial interest in the companies mentioned in this article as of the date of publication. The views/recommendations mentioned in this article, wherever applicable, are those of the respective SEBI-registered Research Analyst/brokerage and have been reproduced/reported with due attribution. They should not be construed as the views or recommendations of The Economic Times Digital or the journalist. Readers are advised to consider the original research report and make their investment decisions based on their own assessment. Brokerage disclaimers here)