India’s small-cap stocks had a year to forget in 2025.
Even though India’s large caps managed to put up a decent showing, the small caps suffered after a strong run in the last 2 years.
High valuations, earnings misses added to its woes.
Most of the stocks are trading below their 52-week highs as well.
Can small-cap investors shake off its underperformance and stage a comeback in 2026?
Analysts suggest stock picking as opposed to passive index investing and to look for fundamentally strong and undervalued stocks.
Smallcap’s underperformance
While India’s benchmark index, Nifty 50, underperformed its Asian counterparts, it still logged a 10% gain in 2025.
Whereas, the Nifty Small Cap 100 index had a 7% decline in 2025, making its worst performance in 3 years after a 14% decline in 2022.
India’s small-cap stocks have rewarded investors handsomely in the last 2 years, with a 47% return in 2023 and 25% in 2024, respectively.
The valuations of the smallcap stocks surged after their strong run, and the stocks were set for disappointment as earnings didn’t catch up to the expectations in the recent quarter.
Earnings miss and overvaluation
Motilal Oswal said almost 40% of the small-cap stocks failed to meet their earnings expectations in the second quarter of FY26.
The firm said small caps saw 5% fall in their earnings growth from the previous year, compared to 3% growth expectations.
According to JM Financials, 32% of the small-cap companies under its coverage underperformed its earnings forecast in Q2FY26.
This earnings miss, compounded with high valuations, led to the underperformance of the high beta stocks.
According to the data by OmniScience Capital Advisors, small-cap stocks are expected to post earnings growth of 11.7% two-year forward earnings growth.
However, the index is trading at a multiple of 29.5 times P/E.
“At this combination of growth and valuation, small-cap stocks appear overvalued relative to their fundamentals.”, the report added.
OmniScience’s report also points out that 63% of the companies within the smallcap segment, which represents around Rs 28 lakh crore, are overvalued.
Analysts also attribute profit booking in the small-cap segment.
Kranthi Bathini, Director – Equity Strategy, WealthMills Securities, said,
“The small caps are high beta in nature. In the last 18 months, contrary to the popular view, mid and small caps have outperformed the largecaps. Now, at the fag end of the year, the large cap started outperforming, whereas the mid cap and small cap witnessed profit booking. Various reasons can be attributed. One is valuation concerns. The large-cap seems to be fairly valued compared to the mid and small caps. The margin of safety is very high in large caps than in the mid and small caps.”
Stocks trading below their highs
87% of the stocks in the Nifty small cap index is trading more than 10% below their 52-week highs, according to data from Trendlyne.
Among these, 36% are trading 30% below their 52-week highs.
Major companies in the index that have surged in the 2023-24 rallies have come crashing down in 2025.
Companies like Reliance Power, Ola Electric, Tejas Networks, and Whirlpool of India were trading more than 50% below their 52-week highs.
Reliance Power, which gained 194% in 2023 and 202,4 fell by 11% in 2025.
A similar thing happened to Tejas Networks with a 95% rally in 2 years and a 61% decline in 2025.
India’s retail investors have high ownership in some of these stocks, according to shareholders’ data.
Public shareholders own 58% of the free float in Reliance Power, and 48% own Ola Electric as per the shareholding data till September 2025.
The retail investors have burned their hands after entering these stocks after witnessing their huge rallies.
Analysts advise bottom-up stock picking for smallcaps
Although most of the small-cap stocks have underperformed, analysts see opportunities for investors who analyse and pick individual stocks rather than investing in the index.
Bathini has said he will look at stock-specific picks among the smallcaps for 2026.
OmniScience Capital, in its report, said that 36.3% of the stocks in the small-cap sector, which represents Rs 16 lakh crore, are fair or undervalued.
Adding to this, the report adds that around 230 companies outside the top 250 companies are also undervalued according to their assessment.
The firm says that these pockets “offer ample opportunities for active investors to generate alpha.”
What should small-cap investors do?
Apart from active stock picking, experts also said investors should clean up their portfolio of underperforming and overpriced stocks.
Vikas Gupta, CEO and Chief Investment Strategist of OmniScience Capital, said, “It wouldn’t make sense to sell at the bottom. But, if you have small-cap stocks that are above 50 P/E and you are not confident that they can maintain the growth rate, then you can sell and get out of it.”
Gupta adds that investors shouldn’t worry about the sunk cost fallacy.
“Don’t look at it in a way that you bought it at Rs 100 and it went to Rs 150, now it’s Rs 60. It doesn’t matter. Look at the current or forward-looking P/E, and if it’s above 50, you should sell out. You are not going to make that much money.”
However, he adds that if a stock is currently available at 20 P/E and you are expecting a 15% growth rate, then it’s better to hold or add positions to it.
“When you are reassessing, first look at the fundamentals before deciding to keep it. You have to clear out highly leveraged companies, low ROE companies, low growth companies, and overvalued companies from your portfolio. You have to sell them and accept the losses.” Gupta said.
As India’s small-cap stocks had a year to forget, investors should look to find undervalued and fundamentally sound stocks for 2026.
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