While the broader markets saw a sharp sell-off earlier this month, a partial recovery in the smallcap indices since March 13 has helped revive the sentiment for smaller stocks.

The percentage of the Nifty Smallcap 100 index stocks trading above their 20-day simple moving averages (SMA) has jumped to over 33 percent from 2 percent on March 13, when the negative sentiment was at its peak.

At the beginning of the year, at least 90 percent of the Nifty Smallcap 100 index stocks were seen trading above their 20-day SMA.

Up to 40 percent rise from March lows

At least 53 smallcaps from the pack of 250 smallcap index constituents have gained more than 10 percent since March 13, and as many as 113 stocks have recovered more than 5 percent.

Swan Energy has gained by 40 percent, GPPL is up by 25 percent, Apar Industries by 21 percent, Hindustan Copper by 21 percent and Jamna Auto by 21 percent since the panic sell-off in broader markets. The Nifty Smallcap 250 index itself has recovered by 6 percent from March lows.

Earnings growth backs rally in small caps, midcaps

The earnings growth in midcap and smallcap firms has been the key trigger for up to 61 percent rally in broader market indices over the past two years. The Nifty Smallcap 150 index PE has expanded by about 10 percent in this period on the back of a 53 percent growth in earnings.

This shows that the valuations may have increased in some pockets of the broader market, but earnings growth has been supportive of the rally over a couple of years, according to Purvesh Shelatkar, head of institutional broking at Monarch Networth Capital. "For the recovery to sustain its momentum, earnings growth will be key in coming quarters," he said.

In a recent report, UBS said that the earnings trend of Indian companies continues to be strong, but regulators’ concerns about froth in small and midcap stocks, speculation in options, and a rapid rise in retail credit may affect tailwinds.

Given the concerns on valuations and observations by the market regulator, small-caps and midcaps may not see the frenzy buying seen in 2022 and 2023, according to Darpan Patil, founder of Rupic Consultancy.

Should you rush?

Experts are quick to caution that looking at the indices may not be a smart way to seek opportunity. Ties in the broader markets. "When it comes to smallcaps and midcaps, I prefer to study individual stocks and take a bottom-up approach, rather than look at the indices for valuation. Also, it is advisable to take a minimum of three-five-year view while taking exposure to small-caps and midcaps,” Kunal Pawaskar, principal officer and head of portfolio management services at Tata Asset Management, said.