Rs 1 lakh crore is chasing small & midcaps, but largecaps have the valuation. Where are India’s next multibaggers hiding?

More than ₹1 lakh crore has flowed into small- and mid-cap funds this calendar year already, underscoring investors’ growing willingness to tolerate volatility in pursuit of higher returns. Yet the market’s valuation equation is beginning to shift as largecaps are trading at a wider-than-usual discount to midcaps, while earnings growth expectations are narrowing the gap.

Data through September shows net inflows of about ₹1.07 lakh crore into mid- and small-cap funds in 2026. Mid-cap funds attracted ₹51,295 crore, while small-cap funds received ₹55,300 crore. Large-cap funds, by comparison, saw net inflows of ₹11,690 crore during the same period.

The flows suggest that investors are becoming more comfortable with volatility and increasingly confident about the long-term growth potential of smaller companies. But strong flows do not automatically translate into returns.


Smallcaps have already had a powerful run. Since April 2023, their market value has risen 2.3 times, compared with a 1.4-times increase for largecaps, according to Carnelian Capital. The Vikas Khemani-led fund house says smallcaps now trade at a premium to largecaps on trailing earnings, making future returns increasingly dependent on the earnings growth that lies ahead.

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Largecaps regain the valuation advantage

The case for largecaps is gaining strength as their relative valuation discount widens. Mahesh Nandurkar, equity analyst at Jefferies, said the risk-reward equation is becoming more favourable for largecaps because of their better relative valuations against midcaps, while the earnings growth gap is expected to narrow over FY26–28.

Largecaps currently trade at a 30% valuation discount to midcaps, compared with a 10-year average discount of 20%, according to Nandurkar. At the same time, the earnings growth gap between the two segments is expected to narrow materially over the period.

“We believe risk-reward is becoming more favorable for largecaps on better relative valuations vs. Midcaps, while the earnings growth gap is narrowing over FY26-28E,” Nandurkar said in a recent report.

He has increased the weight of Reliance Industries in Jefferies’ model portfolio, citing attractive valuations. The stock trades at 8.4 times one-year forward enterprise value to EBITDA, which is 23% below its 10-year average, with the possibility of upgrades if gross refining margins improve.

Largecaps also offer a wider margin of safety in a market where volatility, liquidity risks and earnings disappointments remain important considerations.

How cheap is Nifty?

Vinod Karki of ICICI Securities said the valuation backdrop for the Nifty50 is becoming more supportive.

The Nifty 50’s PEG ratio is approaching the attractive zone of about 1, with its forward price-to-earnings multiple at approximately 17 times and consensus earnings growth expectations at around 16% for FY27, Karki said.

“The PEG of ~1 is amongst the lowest levels seen over the past decade,” he said, adding that earnings expectations appear credible after about 14% year-on-year growth in the first quarter of FY27.

High-frequency indicators for the second quarter also suggest robust nominal aggregate growth, according to Karki. Corporate capital expenditure, financial leverage, corporate profits, discretionary consumption, credit growth and non-performing assets remain supportive cyclical factors, he said.

That combination of reasonable valuations and improving earnings visibility is making largecaps more relevant for fresh allocations, particularly after the strong rerating seen across several mid- and small-cap pockets.

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Smallcaps still offer the deeper pool of winners

The argument for smaller companies, however, has not disappeared. Khemani says smallcaps remain the most direct way to own India’s domestic economy. About 59% of small-cap profits come from the domestic, non-financial economy, compared with 32% for largecaps.

Smallcaps also have greater exposure to healthcare, industrials, consumer discretionary and materials, while largecaps remain more concentrated in financials, energy, information technology and utilities.

The difference is visible in the breadth of earnings growth. Over FY20–26, median small-cap profits grew 19.4% annually, compared with 15.2% for largecaps. Over FY16–26, 279 smallcaps compounded profits at more than 20% annually, compared with only 13 largecaps.

Carnelian estimates that median small-cap earnings could grow 26.6% annually over FY26–28, against 18.7% for largecaps. On FY28 estimates, it argues, the small-cap valuation premium largely disappears.

The fund house also makes a like-for-like comparison. Smallcaps trade at roughly 30 times FY27 estimated earnings against 33 times for largecaps in the domestic, non-financial universe, while their projected FY26–28 profit growth is higher at 22%, compared with 16% for largecaps.

That is why the small-cap opportunity cannot be dismissed simply because the broader segment has become more expensive.

The sharper risk lies in treating the entire small- and mid-cap universe as a single opportunity. Dalal Street’s veteran investor Prashant Jain of 3P Investment Managers said the Nifty MidSmallcap 400 index returned 99% between May 2022 and September 2026, compared with 35% for the Nifty 100. But most of the excess return came from the top 4% of small- and mid-cap stocks — just 16 companies that gained more than 1,000%.

“Most of the outlier stocks in SMIDs are in manufacturing / power equipment etc. or are corporate turnaround cases,” Jain said. “It would therefore be erroneous to conclude that SMIDs as a category outperform or have outperformed.”

Excluding metals and oil and gas, the share of market capitalisation held by small- and midcaps rose from 25% in FY21 to 34% in FY26, while their share of aggregate profits remained broadly unchanged.

That creates a clear distinction between selective stock-picking and a broad-based bet on the segment.

“As a category, large caps are more attractive, though SMIDs offer stock picking opportunities,” the PMS fund manager said. It added that in a scenario of materially higher US yields, downside protection in largecaps would be superior to that of small- and midcaps.

So where are the next multibaggers? The answer may not lie in choosing one market-cap segment over another.

Largecaps now offer valuation comfort, stronger liquidity and a wider margin of safety. The Nifty’s PEG ratio near 1, narrowing earnings-growth gap with midcaps and the 30% valuation discount strengthen the case for a selective rotation.

Smallcaps, meanwhile, continue to offer a wider hunting ground for companies benefiting from India’s domestic growth, manufacturing expansion, healthcare demand and rising discretionary consumption. But the dispersion between winners and losers is much wider, making business quality, governance, balance-sheet strength and valuation critical.

The ₹1 lakh crore flowing into small- and mid-cap funds shows where investor conviction currently lies. The valuation data, however, suggest that the next leg of market returns may not come from simply following those flows.

The multibaggers could still emerge from the small-cap universe. But after a 2.3-times rise since April 2023, investors may need to look beyond category-level momentum. In largecaps, the opportunity may lie in companies whose earnings have yet to catch up with a valuation reset. In smallcaps, it may lie in identifying the relatively few businesses capable of converting high growth into sustained compounding.

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