Ongoing selloff in equity market fails to close mid, smallcap valuation gap

The recent selloff in the Indian equity market has been far more painful for mid and smallcap stocks compared to largecap stocks.

The benchmark BSE Sensex is now down 9.5 per cent from its record monthly closing of 84,300 at the end of September last year.

In the same period, the BSE MidCap has lost 17 per cent of its value, while the BSE SmallCap has corrected by 17.1 per cent.

This has led to an equally sharp moderation in equity valuation across these three market segments.

However, midcap stocks continue to trade at a premium to the largecap index, Sensex, on a price-to-book value (P/BV) basis.

The BSE SmallCap valuation remains lower than that of the benchmark index, but the valuation discount is much lower than in the past.

The Sensex closed at a P/BV ratio of around 4.92 on Tuesday, compared to the BSE MidCap P/B ratio of 4.2X, while the BSE SmallCap is trading at a P/B ratio of 3.3x.

For comparison, the Sensex was trading at a P/B ratio of 24.8x at the end of September last year, and the BSE MidCap was trading at a P/B ratio of 5.1x in the same month.

The BSE SmallCap valuation had peaked in August 2024, when its P/B ratio had reached 4.2x.

Mid and smallcap stocks also continue to trade at a premium to largecap stocks on a trailing price-to-earnings multiple, which is highly volatile compared to the P/B ratio.

The Sensex is currently trading at a trailing price-to-earnings (P/E) multiple of 21.2x, compared to 32.8x for the BSE MidCap and 28.3x for the BSE SmallCap.

In the past decade, the BSE MidCap’s trailing P/E has ranged from a record high of 500x in September 2020 to 20x in March 2020.

Similarly, the BSE SmallCap’s trailing P/E has ranged from a high of 420x in February 2020 to a record low of 1,856x in June 2020.

In comparison, the Sensex’s trailing P/E has ranged from 34.4x in March 2021 to 18.8x in April 2020.

This makes it difficult to compare P/E multiples over the long term, so the Business Standard analysis is based on the P/B ratio, which moves more steadily over time.

Analysts say mid and smallcap indices remain expensive compared to their own historical valuations and those of the benchmark indices.

“Despite the recent correction in stock prices and a moderation in their valuation, mid and smallcap stocks remain expensive relative to largecap stocks.

"This would translate into more pain in these segments compared to largecap stocks,” says Chokkalingam G, founder and managing director of Equinomics Research.

Others say that mid and smallcap valuations will revert to pre-pandemic levels when they traded at a sizeable discount to largecap stocks.

“The post-pandemic surge in the valuation of mid and smallcap stocks is an anomaly, and they will soon trade at a discount to largecap stocks as they did in the past,” says Dhananjay Sinha, co-head of equities and head of research at Systematix Institutional Equities.

In the pre-pandemic period, the BSE MidCap P/B ratio was 14 per cent lower than the Sensex P/B ratio, while the BSE SmallCap traded at a 28 per cent valuation discount compared to the benchmark index.

This suggests further underperformance for small stocks going forward.