India’s smallcap stocks are currently going through a deep correction. After delivering exceptional returns in 2024, the mood completely shifted in 2025 as the market witnessed its sharpest drop in seven years. This sudden reversal has raised serious doubts about the direction and strength of the market. While historical trends point toward a slowdown similar to 2018, some analysts are forecasting strong gains next year. This contrast is what makes the current situation both complex and intriguing.
Is this fall merely a healthy correction, or are we heading toward a deeper downturn? Will 2026 turn into a nightmare for investors or become a year of recovery? Let us explore the answers to these pressing questions.
What’s Happening?
India’s smallcap market is going through its weakest phase in 2025. Market data up to November clearly shows the depth of the decline. Nearly 1,000 listed companies have fallen more than 20% from their all-time highs. More concerning is that 440 stocks have crashed over 50%, and many shares have even recorded losses of up to 90%.
Looking a little further back makes the picture even clearer. This drop represents the worst phase for smallcaps in the last seven years. For market experts, the situation is reminiscent of 2018, a year when smallcaps went through a long and painful downturn. After the sharp rally in 2024, the end of 2025 has become a reality check for investors.
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Earnings-Valuation Mismatch
The biggest reason behind this crash is not sentiment but fundamentals. The harsh truth of the market is that while stock prices shot up like a rocket, company earnings did not grow at the same pace. Analysts call this the earnings-valuation mismatch.
Even though the Nifty 50 is close to its all-time high, nearly 73% of Nifty 500 stocks are still trading more than 10% below their record highs. The situation is even worse in the smallcap segment. Ever since the bear market was confirmed earlier this year, the Nifty Smallcap 100 Index has struggled to recover. It is still around 13% below its 2024 peak, and the more serious concern is that nearly half of the companies in the index are trading more than 50% below their all-time highs. This is not just a correction; it is the market’s way of resetting itself.
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Recovery Moving Away from High-Valued Smallcaps
According to Reuters, a broad market recovery is still far away because valuations remain elevated. While the Nifty 50 is trading close to its 10-year average P/E, midcaps are at a 12-month forward P/E of 29.2x and smallcaps at 25.1x, which is much higher than their long-term averages of 23.1x and 16.7x, respectively.
At the same time, the current weakness has hit retail investors the hardest. They account for 35% of NSE’s cash market activity and hold 8.6% ownership in NSE-listed companies. Their large exposure to small and midcaps combined with volatility and lower liquidity, has increased their risk significantly.
According to Harsha Upadhyaya, CIO of Kotak Mahindra AMC, either valuations will fall further, putting more pressure on smallcaps, or earnings in the second half will recover sharply enough for midcaps and largecaps to outperform.
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What Does This Mean for Investors?
The signals for investors are clear; the risk in smallcaps has now increased more than ever. Retail investors are selling smallcap shares on a large scale, which could push this segment into deeper losses in 2026. In just this quarter alone, net selling has crossed ₹30,000 crore, potentially becoming the biggest quarterly sell-off in two years. Its impact is clearly visible on the index. The BSE Smallcap Index, which delivered 47.5% returns in 2023 and 29.3% in 2024, is now down 9.45% in 2025, its worst year since 2018. This decline shows that after almost a 93% rally in just two years, the market is now resetting itself rapidly.
What’s most concerning for investors is the breadth of the fall; the decline isn’t limited to any single sector. Telecom, infra, real estate, engineering, textile, financials, media, IT, pharma, defence, and renewables are all sectors that are part of this downturn.
What’s Next?
The outlook for the future appears mixed. On one hand, earnings pressure is clearly visible; on the other hand, signs of recovery are also emerging. According to Motilal Oswal, smallcap earnings fell 5% YoY in Q2, despite expectations of 3% growth, and 40% of companies missed their guidance. In comparison, only 19% of largecaps and 22% of midcaps missed expectations. This indicates that the pressure is much deeper in smallcaps, but the picture is not completely negative.
Looking forward, both technical and fundamental indicators suggest that a bounce in the smallcap index is possible. India’s strong economic momentum, potential RBI easing, stabilizing demand, and falling input costs could form the base for earnings recovery in H2 FY26. According to Mint, analysts believe that as the valuation-earnings gap narrows, a more balanced and sustainable recovery may take shape. Technically, the Nifty Smallcap 100 is expected to see nearly 25% potential upside by the end of 2026.
*The article is for information purposes only. This is not investment advice.
*Disclaimer: Teji Mandi Disclaimer
