A Tale of Two Worlds!

A friend who runs a family business and has actively started investing in equities post Covid, called me recently with a lot of anguish. He said “ The headlines that I read in the last few months of Nifty touching all time high, Gold & Silver soaring, GDP growth above 8% and record GST collections - does not reflect in my portfolio performance at all. What’s going on!”

Well, its a tale of two worlds - small-caps vs large-caps (And metals is in a different galaxy of itself!) - last year has truly seen some contrasting performance. Retail / HNI investors, like my friend, generally have a micro and small cap heavy portfolio - and hence the last year has been tough on most. Let’s look at some data which brings out the contrast clearly!

52-week low/high

Small Companies (below 10k Cr Mcap) have seen a median fall of 27 - 35% from peak in last 1 year vs 12 - 16% for Large Companies (> 50k cr Mcap).

When we look at stocks near their 52wk low & high - Small Companies have >25% companies near 52wk lows and <10% companies near 52wk highs. Its quite the opposite for Large Companies where 55% are near 52wk high and only 10% near 52wk lows.

Q2 Financial Results

Looking at the latest quarterly results for Sep’26 - its clear that while small companies are able to get better revenue growth vs Large companies (partly because of price increases done to pass on high commodity costs & partly due to base effect), but at EBITDA & profitability levels Small caps have struggled.

Small caps have seen average margin contraction of up to 0.7 %pts vs Mid & Large caps have seen average margins expand by 1.4 - 2.2 %pts.

Valuations

While the quoted P/E for Nifty50 comes closer to ~22x, but when we dissect it we realize that’s not the case. Mid & Large-caps Median TTM P/E multiple is at 35-41x, which is significantly higher vs long-term average. After the recent correction, small-cap valuations have softened a bit to 22-30x TTM PE, though still above average.

Index Performance

Large-cap & Mid-cap index have delivered 1-year positive returns of 7-8% whereas Small-cap & Micro-cap index have been -ve 3-4%. However, if we look at a 5-year return period, Small & Micro-cap have given 28% & 38% CAGR respectively (which is much higher than long-term averages!) and also higher vs Large-cap returns of 18%.

Size Premium and when does it work?

Size Premium (smaller companies’ ability to generate better returns due to their size advantage) does not work all the time, as we just saw. Small-caps generally work when there is an overall bull market/ Risk-on sentiment resulting in broader market participation.

So can we use some quantitative ratios to guide us on this small-cap vs large-cap allocation? The answer is yes.

Ratio of Nifty50 Index to Smallcap 250 Index is a powerful one (though not the only one obviously) - it takes into account the relative valuations & price movements and can be a good indicator when we think of allocations between small-cap vs large-cap.

We are currently near 1.5 ratio, which is similar to the level in 2008 and 2018, during which period the small-cap returns were significantly negative:

• 2008 : Smallcap returns -ve 71% vs Nifty50 -ve 55%

• 2018 : Smallcap returns -ve 28% vs Nifty50 +ve 4%

The basic idea of this indicator is that at lower ratios we tilt towards Large-caps and at higher ratios we move to Small-caps. Just by using this simple rule, we created an automated quant portfolio - check out the results below:

With a simple rule-based portfolio and investing into the same indices (Nifty50 & Smallcap 250), we are able to generate an alpha of ~130bps (over 20 years!) vs Small-cap index, while reducing drawdown & volatility at the same time!

Conclusion

As we look to step into 2026, we must remember, that we are still at the lower-end of the Nifty 50 to Smallcap 250 ratio - which is a cautious zone, small-caps are still under-going margin pressure and while markets have corrected, valuations are still rich vs historical levels. Let’s see who wins the battle between Small-caps & Large-caps in 2026!

Disclaimer: This is purely for education & research purposes only. Nothing in this should be considered as an investment advice. Please consult your SEBI-registered investment advisor before taking any financial decisions.