Small Cap Opportunity Re-emerges: Bajaj Finserv AMC

A study by Bajaj Finserv AMC suggests that small caps may be approaching a favourable entry point, supported by improving fundamentals, a potential earnings recovery, corrected valuations, and historically strong rebound patterns. 

The study highlights a disciplined approach to investing in small caps, focused on identifying fundamentally strong businesses with long-term potential. For investors, this means prioritising companies with solid financials, consistent earnings, and sustainable competitive advantages, while also capturing growth opportunities driven by strong business models and future expansion. 

The small-cap universe has undergone a significant structural transformation in recent years. Companies are increasingly funding expansion through internal cash flows rather than borrowing, resulting in healthier balance sheets and improved profitability metrics. Aggregate capex in the segment increased from approximately ₹2.2 trillion during FY19–FY22 to nearly ₹3.4 trillion during FY23–FY26, while net debt-to-equity levels declined sharply from 0.52x in FY19 to near-zero levels in FY26. During the same period, return on equity (ROE) improved from 9% to 12%, reflecting stronger financial discipline and sustainable business models.

Domestic Institutional Investors (DIIs) have been gradually increasing their exposure to the small-cap segment, primarily through SIPs. This trend is encouraging as SIP-driven flows tend to be more stable and long-term in nature, which could help reduce volatility in the small-cap space over time. At the same time, retail ownership has moderated slightly, which may reduce excessive speculation.

The fund house highlights that recent market corrections have also created opportunities for valuations supported by earnings growth and contextual factors, with nearly 50% of small-cap stocks trading below their 10-year average valuations, one of the highest such readings in recent years. The study also notes that this broad-based correction has helped clear overvaluations from the market and created selective opportunities in fundamentally strong businesses.