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Small-cap stocks have been under pressure in 2025, making it one of their toughest phases in recent years, but market experts now believe this weakness may actually be setting up a favourable entry point.

After a strong two-year rally, the segment has sharply underperformed in 2025, and valuations have cooled significantly. For long-term investors, this could be the right moment to start looking at quality names in the small-cap basket.

The Nifty Smallcap 100 index has fallen more than 9% year-to-date, turning sentiment negative among retail investors, who hold a large share of ownership in these companies. This decline comes after two blockbuster years - the index gained 24% in 2024, after a massive 56% jump in 2023.

In the last one year, the Nifty Smallcap 100 has dropped 11%, as gaainst 7% rise in the Nifty 50, reinforcing the dominance of large caps in the current market cycle. The weakness has continued across shorter timeframes as well: the index is down almost 7% in the last six months and 6% in the last one month.

The sharp decline in small-cap stocks is the result of several factors that have built up over time.

One major reason is stretched valuations. Even before the present correction began, the Nifty Smallcap 100 was trading at levels that analysts considered unsustainable. Despite a year of consolidation, valuations remain elevated. Experts believe only a meaningful improvement in earnings can help bring the index back to fair value.

Earnings performance has also been weak. While large-cap companies delivered strong numbers in the september quarter (Q2 FY26), small caps lagged sharply behind. Out of the Nifty Smallcap 100 constituents, around 90 companies reported only 1.5% growth in consolidated net profit.

Furthermore, foreign investor sentiment has also played a key role. FIIs continued to trim their exposure to India’s broader markets in the September quarter. Finally, investors have been booking profits after the strong run-up till late 2024. With large caps delivering more stable and predictable returns over the past year, many long term investors shifted their capital away from riskier pockets.

Historically, small-cap surges are often followed by time corrections lasting several months, and 2025 has been no different.

Despite the recent pain, analysts believe the correction has created a healthier environment for long-term investors. The risk-reward profile appears far better today compared to the peak of the rally in 2024.

The possibility of a cyclical revival in 2026 is strong if broader earnings improve, domestic SIP flows stay robust and global interest rates stabilise or decline. In such a scenario, small caps — especially financially strong and well-managed ones — may reclaim leadership.

Market experts also highlight that the froth of the past year has now settled. Viraj Gandhi, CEO of SAMCO Mutual Fund, said, “Excess froth has cooled, valuations have normalised, and the segment is healthier today than during last year’s euphoric phase.” He added that this environment offers a favourable entry window for investors willing to hold for at least five years.

While near-term volatility is likely to continue, improving macro stability, easing inflation, and consistent domestic flows may help support the segment. However, analysts warn that the recovery will depend on earnings strength, liquidity conditions and disciplined valuations.

As one fund manager noted, “The set-up for smallcaps is improving, but the leadership in 2026 will depend on quality. Over-leveraged names may continue to struggle even if the cycle turns favourable.”

With prices cooling and fundamentals gradually stabilising, small-cap stocks may finally be offering the kind of long-term opportunity that disciplined investors look for — provided they stay selective and focus on quality.

Nifty Smallcap 100: Technical ViewThe Nifty Smallcap 100 index continued to show signs of pressure in its ongoing corrective phase, hovering near the 17,140 mark after profit-booking dragged it down from recent highs around 19,000. According to Aakash Shah, Technical Research Analyst at Choice Equity Broking, the index is attempting to stabilise near the 17,000 support area, hinting at emerging buying interest and the possibility of a short-term base.

Shah noted that the index remains below its 20-week and 50-week EMAs — both placed in the 17,600–17,800 band — signalling near-term weakness and acting as immediate resistance. However, it still trades above the 100-week EMA, indicating that the broader structure remains intact despite the correction.

A sustained weekly close above the 20-week EMA would be an early sign of strength, while a breakout above the 50-week EMA could confirm a trend reversal. On the downside, Shah highlighted the 16,800–16,700 zone as a crucial support region, warning that a breach could push the index toward 15,765 — the May 2025 swing low and a key demand area.

If the index manages to sustain above 17,800, Shah said it may gradually move toward the 18,800–19,000 resistance zone, though he emphasised that rising volumes will be essential to validate any recovery.

Disclaimer: The views and recommendations made above are those of individual analysts or broking companies, and not of Mint. We advise investors to check with certified experts before making any investment decisions.

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