Small-cap stocks have delivered a strong performance this year, outperforming their large-cap counterparts as robust earnings growth and sustained domestic inflows continue to support the segment.
The benchmark Nifty 50 index has declined 7.5% on a year-to-date (YTD) basis. In contrast, the Nifty Smallcap 100 index has rallied more than 12%, while the Nifty Midcap 100 index has gained over 5% during the same period.
Most small-cap companies have reported strong earnings growth of around 30% year-on-year (YoY), outperforming large caps. The growth has been supported by a favourable base and driven primarily by the Financials and Oil & Gas sectors.
The outperformance of small-cap stocks has been driven by investors moving down the market-cap curve in search of higher growth, favourable sector dynamics and structurally sound business models, according to Utsav Verma, Head of Research at Choice Institutional Equities.
The shift is also reflected in domestic investor flows. The small-cap segment accounted for nearly 56% of new folios in July 2026, indicating a preference for smaller companies at the expense of relatively slower-growing large caps.
Is Small-Cap Outperformance Sustainable?
Verma believes the outperformance can remain sustainable, but only where it is supported by strong fundamentals and credible earnings growth visibility. However, he cautioned that valuations leave limited room for disappointment at current levels.
The Nifty Smallcap 250 is trading around 5 points above its five-year average price-to-earnings (PE) multiple of 27.0x. In comparison, the Nifty 50 is trading around 2 points below its five-year average PE of 22.1x, suggesting that small caps remain relatively stretched on valuations.
“A slowdown in equity fund flows could trigger redemptions and weaker SIP inflows, precipitating a broader de-rating of the segment. We, therefore, believe selective, not broad-based exposure can lead to superior alpha generation,” Verma said.
He prefers small-cap companies with demonstrated earnings visibility and strong balance sheets, rather than taking broad exposure to the segment, given the asymmetric downside risk in the event of a flow-driven correction.
Top Small-Cap Stock Picks
Choice Institutional Equities prefers Garden Reach Shipbuilders & Engineers in the defence sector, citing strong order-book visibility and continued government thrust on indigenisation.
In the automobile and auto-ancillary space, the brokerage favours Lumax Auto Technologies and Minda Corporation, supported by a steady recovery in OEM demand and increasing content per vehicle.
The brokerage is also positive on Man Industries (India), which it views as a beneficiary of capex-led pipeline and infrastructure order inflows. In pharmaceuticals, it prefers Granules India, citing margin stability and export-led earnings visibility.
“Beyond our core sector preferences, we also like Yash Highvoltage as a beneficiary of the ongoing power capex upcycle, Smartworks Coworking Spaces on the formalisation of commercial real estate and rising managed workspace demand, Jeena Sikho Lifecare and Yatharth Hospital & Trauma Care Services on healthcare capacity expansion and improving occupancy-led earnings growth,” Verma said.
On a bottom-up basis, the brokerage also favours Bajaj Consumer Care, citing an improving demand outlook and valuation comfort; Fractal Analytics, which stands to benefit from structural tailwinds in enterprise AI and analytics adoption; and Allied Blenders & Distilleries, supported by continued premiumisation-led volume growth.
In the oil-refining space, Choice Institutional Equities likes Chennai Petroleum Corporation and Mangalore Refinery and Petrochemicals, citing favourable refining margins amid the ongoing West Asia conflict.
It also favours Capri Global Capital, supported by healthy credit growth in the MSME and affordable housing segments.
Within metals and mining, Verma prefers Monolithisch India as a play on sectoral tailwinds. In the organised jewellery space, he likes Shanti Gold International and Shringar House of Mangalsutra, citing the ongoing formalisation of the B2B gold jewellery business.
Overall, Choice Institutional Equities expects small-cap stocks with strong earnings visibility, healthy balance sheets and structural growth drivers to continue delivering opportunities. However, given elevated valuations, the brokerage believes investors should remain selective rather than take broad-based exposure to the segment.
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