Not All Mid & Small Cap Investors Think Alike — Two Types That Destroy Returns

Last week, a strong debate happened between Mr Sharma and Mr Khanna on mid-cap and small-cap valuations. As per Mr Sharma, investors are often hesitant to consider mid-cap and small-cap investments when approached by a financial advisor.  To them, the valuations are high, and the growth outlook is negligible and more downward trend. 

There is physiological reasoning behind the same due to which clients are reacting. Furthermore, the price of Gold and Silver has created more issues regarding the investment decisions made at the family level. Whereas Mr Khanna has a strong point on the high valuations of midcap and small cap currently, and hence not a conducive market to invest.

Mr Sharma jumped on this point, and his opinion was that what valuations are we highlighting? Are we speaking about price-based valuation or price correction valuation, or are we speaking about those stocks where prices are still stuck from the highs of September 2024?  

On what basis have the valuations been derived that the whole space of midcap and small cap is expensive?  The real physiological point of expensive derived from a different segment of the client investments.  The midcap and small-cap stocks are indeed overvalued, but for two types of clients whom we follow blindly, just like a herd mentality, 1) Traders, 2) who have old stocks and are unable or were not able to dilute.

Investors are saddled with a long list of non-performing stocks accumulated from 2020 to September 2024. Further, they waited for more than 1 year to recover, but unfortunately, in many of the stocks, the same did not materialise. For those traders, it is obviously overvalued, where, based on the influence of financial advisors, they have asked their clients to invest in worthless companies based on the euphoria of the rally.

In many clients, it has been found that the frustration has gone up significantly since the stocks that they are holding are not moving post correction, whereas someone has got significant rally post September 2024 correction.  This has taken a further toll on the client's mind.

Under these circumstances, you, as a financial advisor, will not only find it hard to convince a client to invest in midcap and small-cap stocks but also in equities. Those who are 1^st time brave investors in equity before the correction of Sept 2024 will find it more difficult to convince.

When we derive the number of midcap and small-cap valuations on different parameters, we find:

1) Interest Coverage Ratio (ICR) measures a company's ability to pay interest on its debt from operating earnings, calculated as EBIT divided by interest expense.

 

 2) Debt to Equity Ratio: Midcap and small cap companies in India maintain moderate Debt-to-Equity (D/E) ratios currently, averaging 0.4-0.7 for midcaps and 0.6-1.0 for small caps as of early 2026, reflecting deleveraging trends post-pandemic [ from prior]. These levels indicate improved financial stability compared to peaks above 1.2 a decade ago

 

 3)     Market Capitalisation growth:10-Year Growth Trends

Over the past decade, midcap market cap surged from ~₹10 lakh crore in 2016 to current levels, a 4-5x rise fueled by multibagger rallies and index inclusions [ from prior]. Small caps expanded similarly from ₹5-7 lakh crore, though with higher volatility—peaking in 2024 before 2025's 7-10% drop

4)     ROCE-Midcap companies in India currently average Return on Capital Employed (ROCE) around 15-20%, outperforming small caps at 12-18% as of early 2026, reflecting efficient capital use amid economic recovery. 

Hence, the above parameters of valuation make it very clear that Midcap and small cap is at the right time for investing. The overvaluation hype is more of those two categories of investors, as mentioned earlier.

For a dealer in stock broking, it is difficult to generate revenue when the broader market rally is missing. Most importantly, there is a difference between a financial advisor and broker/dealer of equities.  In many places, investors have mingled both of them, which leads to a lack of clarity on the valuation perspective.

It’s agreed that the global economy is shifting, and hence the return expectation will change at the same time; one will have to follow the words of the financial advisor rather than just following what the market says.

Midcap and small cap will have a golden period going ahead since the current trade war has opened many doors that were closed for more than a decade. The trade agreements with new countries, including India, will play a pivotal role for mid-cap and small-cap companies.

The cost of borrowing has come down due to RBI policy actions, and a further rate cut would help the midcap and small caps. If we look at the borrowing cost, we find that Indian banks are having healthy position and not much borrowing growth has been witnessed in the last couple of years.

The debt-to-equity ratio of midcap and small is significantly low as compared to the historical levels. If we look at the cash flows of midcap and small cap, we don’t get any negative markings or threats.

The market is an opportunity for creating wealth and not short-term gains. From 2020 to 2024, investors have made short-term profits where money has doubled. Those days are gone.  Every index will have companies where there is a wide disparity of valuations; at the same time, you will get reasonable valuation companies.

Conclusion:

From 2020 to September 2024, every fund manager in the mutual fund industry has performed as the market rally was broader, but now the real test begins in stock picking and sector picking ability of the CIO and Fund managers.  Hence, the last 5 years' returns will not help investment decisions from here onwards.  Don’t trust blindly on over valuation herd mentality. There are many pockets where valuations are attractive, and the quarterly results are also very strong. The midcap and small-cap space has resurrected and is poised for huge growth for wealth creation, and not for short-term traders. Those who are looking for wealth creation for the next 5 years or above, this is the best time to invest in midcap and small-cap stocks.  

The upcoming trade agreements with India will bring a huge rally for the midcap and small-cap stocks across sectors.  The reason is that every deal with a different country will bring cumulative growth opportunities for every company.  Those who are strong supporters of Large cap well, they have started treating large-cap stocks just like bank FDs. Bank FD’s failed to beat inflation for a generation of investors. Now the large cap is being treated in the same fashion. Large-cap stocks will not grow as much as midcap and small cap who will change their buckets in the next 10 years. It's time for midcap and small-cap.