Midcap rally hides a deeper split: Every second stock down but index up 11% in 1 year. Are investors walking on thin ice?

The Nifty Midcap 150 index has comfortably outperformed the benchmark Nifty in the last one year, gaining about 11% compared with a steep 6% decline in the Nifty. But beneath that headline performance lies a more uneven picture. Stock-level data shows that more than 50% of the index constituents are still trading in the red, with losses extending to as much as 70%.

SKF India, KPIT Tech, Syngene International, RVNL, P&G, Patanjali Foods, Gujarat Energy, Tata Elxsi, Aditya Birla Fashion, Emami and Hindustan Petroleum are among the worst performers.

At the other end of the spectrum, Vodafone Idea had doubled at 100% to lead the charts. Federal Bank, Gland Pharma, Hitachi Energy, Sonal BLW, Oracle, Vodafone Idea and Aurobindo Pharma are among the other strong performers.

Retail investors are buying heavily

The appetite for mid and smallcap stocks remains strong, with investors favouring them over their large-cap counterparts amid improving earnings momentum and higher market liquidity. The trend is clearly visible in fund inflows during the current fiscal year.

Midcap funds garnered Rs 23,218 crore, nearly 44% of the Rs 52,800 crore invested in FY26. In contrast, large-cap funds attracted just Rs 4,863 crore during the period, only about 20% of the Rs 24,000 crore inflow recorded in the previous financial year.

The pace of inflows has also been stronger this fiscal year compared with FY26. In the first four months of the past year, smallcap funds attracted 42% of their full-year FY25 inflow, compared with 36% for midcap funds and 33% for largecap funds. In FY26, smallcap funds attracted Rs 17,723 crore in the first four months, mid-cap funds received Rs 15,059 crore, while large-cap funds collected Rs 7,741 crore.

Who’s doing the heavy lifting?

The sharp headline performance of the midcap index is being driven by a relatively narrow set of stocks, even as a much larger group struggles to keep pace.

“A handful of stocks with strong earnings delivery or a structural growth story, data centres, defence, select financials have done the heavy lifting, while a much larger set of names like cyclicals still working through cost pressure, commodity-linked businesses, and companies whose 2024 re-rating simply outran their earnings, have gone nowhere or fallen,” Tanvi Kanchan, Associate Director at Anand Rathi Shares and Stock Brokers told ETMarkets. “The index return is flattering the average; the median stock tells the real story.”

Since September last year, many small-cap companies have strengthened balance sheets, reduced leverage and improved debt-to-equity ratios, making them better positioned to withstand business cycles, Dinshaw Irani, CEO, Helios Capital Asset Management said.

He added that the large-cap universe includes several sectors facing earnings pressure, particularly IT and FMCG. This divergence in earnings prospects is making small-caps and mid-caps relatively more attractive to investors, despite their higher inherent risk.

Are midcap investors walking on thin ice?

The strong rebound in mid and smallcap stocks has also brought valuations and the margin of safety into sharper focus. Analysts are increasingly pointing to selectivity rather than a broad-based approach as the better way to navigate the segment.

“We see pockets of excess building precisely in these smaller segments, where aggressive rallies leave limited room for disappointment. A selective rotation toward largecaps looks prudent, given frontline equities now offer relatively better comfort with the Nifty50 trading near its long-term average of 18x forward earnings,” Rajesh Palviya, Head of Research at Axis Direct said.

“Allocations to mid and smallcaps should be selective and measured. After their sharp three-month rebound, valuations in this space leave a narrow margin of safety and little room to absorb earnings disappointments,” he added.

The sharp three-month rebound in midcap and smallcap stocks has therefore left investors with little room for earnings disappointments, prompting experts to suggest a selective shift toward largecaps.

“The Nifty Midcap 150 currently trades at a P/E of ~26x, marginally below its 5-year avg. However, this headline multiple conceals substantial dispersion, with several constituents trading at significantly higher valuations despite varying earnings quality and return ratios. At current levels, investors are still being compensated in select pockets where earnings growth remains robust, but the risk-reward has become less favourable for midcaps trading well ahead of their fundamentals,” Antu Eapen Thomas, Senior Research Analyst, Geojit Investments, told ETMarkets.

What should investors do?

For investors looking to enter the market after the recent rally, analysts are urging caution rather than a rush to chase stocks that have already run up sharply.

Rajesh Palviy says Nifty50 valuations are near their long-term average, offering better comfort for fresh allocations than increasingly expensive pockets of the broader market following their recent surge.

Large-cap stocks are emerging as the more compelling segment of India’s equity market after the sharp rally in mid and smallcap shares, according to Rahul Baijal, Senior Fund Manager – Equities, HDFC AMC, who echoed the view. While valuations across the broader market have moderated from their September 2024 peaks, Baijal sees blue-chip companies offering a stronger mix of earnings visibility, governance and relative valuation comfort.

Analysts broadly agree that staggered, selective buying makes more sense than waiting for a broad correction that may not come, given how uneven the rally already is. A chunk of the index is already trading at levels that would qualify as corrected. SIP-style entry into quality names, rather than lump-sum chasing the winners, is the more defensible approach here.

“Businesses with visible earnings delivery, not just a good story, sectors like financials, private banks, select NBFCs, AMCs with expanding fund flows, pharma with clean US/export franchises, and capex-linked industrials with order-book visibility. Favour companies where the last two-three quarters of results have matched or beaten the valuation re-rating already priced in,” Tanvi Kanchan said.

Will lagging midcaps bounce back?

The laggards could find their footing if the broader domestic earnings recovery gains momentum. A broadening of the domestic earnings recovery, rate cuts feeding through to consumption and credit growth, and a sustained pickup in capex execution would lift the laggard cyclicals and financials that have been sitting out the rally.

Continued FII re-engagement with India, particularly if it broadens beyond the financials-led buying seen in August, would help too.

For now, the midcap story remains a tale of sharp divergence rather than a broad-based rally. While strong earnings delivery and structural growth opportunities continue to support select stocks, elevated valuations and uneven performance leave little room for indiscriminate buying. The next leg of the market is likely to depend on how earnings catch up with valuations and whether the recovery broadens beyond the pockets that have led the rally so far.

(This article has been written by Veer Sharma, who is not a SEBI-registered Research Analyst or an Investment Adviser. Veer Sharma 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)