Largecaps are shrinking, smallcaps are getting bigger: What is changing in India’s stock market?

India’s stock market hierarchy is undergoing a quiet but significant shift. Largecaps, long seen as the core of institutional portfolios, are losing their share of the market even as mid- and smallcap companies expand their footprint. The combined market capitalisation share of mid- and smallcaps reached a record 43.7% in September, while the share of the top 100 companies fell to a low of 56.3%, according to data from Motilal Oswal Financial Services.

The shift has been accompanied by a sharp performance gap. In the first half of FY27, the Nifty50 rose just 1.3%, while the Nifty Smallcap 250 gained 24.6%, according to Prateek Nigudkar, senior fund manager at Shriram AMC.

“The defining feature of the quarter was the sharp divergence between largecaps and the broader market,” Nigudkar said.


The divergence, however, is not necessarily a straightforward verdict on fundamentals. It has been shaped significantly by the direction of capital flows. Foreign investors, who typically own a larger share of India’s biggest companies, have been selling largecaps as global bond yields rose, the rupee weakened and oil prices climbed. Domestic institutions, supported by steady systematic investment plan inflows, have directed more money towards mid- and smallcap stocks.

“Largecaps, owned heavily by foreign investors, have borne the brunt of global risk-off selling, while smaller companies, owned mostly by domestic investors, have been cushioned by steady SIP inflows,” Nigudkar said.

That flow-driven divergence has created a new market paradox where smaller companies now account for a record share of India’s market, but largecaps are beginning to look more attractive on valuations.

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Midcaps emerge as the middle ground

Midcaps, companies ranked 101 to 250 by market capitalisation, are increasingly being viewed as the market’s compromise between growth and stability.

They have moved beyond the survival risks associated with early-stage smallcaps but still offer greater revenue growth potential than mature bluechip companies. That combination has made the segment particularly attractive to investors seeking long term wealth creation without taking the full risk of the smallcap universe.

“If you look at returns, growth and midcap funds are labelled as high long-term wealth creators over five- to 10-year horizons and frequently outperform large-cap benchmarks due to the higher earnings-growth trajectory of mid-sized corporates,” said Pankaj Mathpal, founder of Optima Money.

Midcap companies also tend to receive less analyst coverage than large, widely owned stocks. That can create room for active fund managers to identify businesses before they become institutional favourites.

“Unlike large-cap stocks that are covered by dozens of global analysts, mid-cap companies often trade at reasonable valuation multiples before being broadly discovered by institutional investors, allowing mutual-fund managers to capture strong upside as companies scale up,” Mathpal said.

The opportunity is not limited to conventional growth companies. Midcaps also contain value stocks, potential acquisition targets and businesses built around niche or differentiated models.

“In the long term, midcaps tend to give better returns as there are a huge number of deep-value stocks, growth stocks and stocks which provide acquisition opportunities,” said Prateek Nigudkar of Shriram AMC. “There are also many companies with unique business models in this space which are not available in the large-cap segment.”

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Smallcaps have become the domestic India trade

The case for smaller companies goes beyond their recent outperformance. Vikas Khemani, founder of Carnelian Capital, argues that smallcaps offer the most direct exposure to India’s domestic economy.

Smallcap market value has grown 2.3 times since April 2023, compared with 1.4 times for largecaps. Yet Khemani argues that investors should not automatically shift to largecaps simply because smallcaps have rallied. “Small caps are the most direct way to own the domestic India story,” Khemani wrote in a recent investor note.

According to Carnelian’s analysis of 1,594 listed companies, 59% of smallcap profits come from India’s domestic, non-financial economy, compared with 32% for largecaps. The smallcap universe also has a higher representation in healthcare, industrials, consumer discretionary and materials.

That sector mix matters because India’s next phase of growth is expected to be driven by domestic manufacturing, healthcare, retail, infrastructure and consumption. Carnelian said none of the nine listed electronics manufacturers and none of the 13 railway companies in its universe were largecaps, while only one of 15 hospital and diagnostics companies qualified as a largecap.

The earnings data also supports the argument for a deeper pool of growth companies. Over FY16–26, 279 smallcaps compounded profits at more than 20% a year, compared with 13 largecaps, according to Carnelian’s analysis. Top quartile smallcaps grew profits by 27% annually during the period, against 18% for top quartile largecaps.

Since April 2023, 354 smallcaps have more than tripled in value, while 171 have lost money. That makes the segment a stock-picker’s market rather than a broad-based allocation story.

The valuation warning

Midcap valuations ended September at a 52% premium to the Nifty, compared with a long-term average premium of 27%, according to Axis Mutual Fund. The smallcap premium reached a record 30%.

“While headline indices have corrected, expectations embedded in parts of the broader market remain elevated,” Axis Mutual Fund said.

A fall in stock prices does not automatically mean that the broader market has become cheap. Several mid- and smallcap stocks continue to discount strong earnings growth, leaving them vulnerable if business performance fails to match expectations.

Axis Mutual Fund said the September correction had improved the risk-reward in parts of the largecap segment, while mid- and smallcap valuations would require strong earnings delivery to justify their premiums.

The fund house said the market was moving away from a phase driven by liquidity and broad-based re-rating towards one in which earnings delivery, business quality and the price paid for growth would determine returns.

Motilal Oswal’s data presents a similar valuation contrast. The Nifty 50’s one-year forward price-to-earnings ratio fell to 17.2 times, an 18% discount to its long-term average of 20.9 times. Midcap valuations fell to 22.8 times, slightly below their 10-year average, while smallcaps traded at 23.2 times, still a 33% premium to their long-term average.

That leaves investors with two different propositions. Largecaps offer valuation comfort after a period of underperformance, while mid- and smallcaps offer stronger structural exposure to domestic growth but at a price.

Is the market shift sustainable?

The answer may depend on whether the current performance gap is eventually supported by earnings. So far, the evidence points to both a liquidity effect and a genuine change in the composition of India’s growth economy. Domestic flows have supported smaller companies, while the largecap universe has been weighed down by foreign selling. At the same time, small and mid-sized companies have delivered faster earnings growth across several sectors.

But the higher market cap share of smaller companies also raises the bar. The segment can continue to outperform only if earnings catch up with the valuations already embedded in stock prices.

As Axis Mutual Fund put it, the market is becoming increasingly selective, with returns likely to be driven by “the relationship between earnings growth, business quality and the price being paid for that growth.”

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)