From Crash to Comeback: Small Caps Shine After H1CY25

By Lekhan

Small-cap Stocks Shine Bright After the Mid-Year Slump

The Indian small-cap stock segment in 2025 has been a vivid reminder of how unpredictably rewarding investing in smaller companies can be. The first half of the year was tough – with many small-cap investors feeling anxious and drained as prices fell sharply and market sentiment weakened. However, as the mid-year approached, this gloom lifted dramatically, and small-cap stocks mounted a powerful comeback that few expected.

The Early Year Downturn

The start of 2025 saw small-cap stocks lagging far behind their larger peers. While blue-chip indices like the Sensex and Nifty 50 gained around 8%, small-cap stocks slipped by nearly 2%, and midsized companies barely managed any growth. What was more alarming was the scale of damage beneath the surface: close to 170 small-cap companies lost at least a quarter of their value. This led to growing concerns and headlines that painted a picture of fear and sell-offs.

This selloff resulted from a mix of global uncertainties and domestic challenges. Foreign investors, traditionally cautious in times of global turmoil, pulled funds aggressively in response to geopolitical tensions and trade disruptions. Smaller companies bore the brunt due to their vulnerability to supply chain issues and disappointment in earnings during the December quarter. Companies’ dependent on borrowing was also hurt by slow credit growth. By spring, the small-cap index was down 14%, with midcaps down nearly 9%.

The overvaluation of many small companies, shown by high forward price-to-earnings ratios, made investors wary of committing fresh capital without strong earnings growth signals.

The Silver Lining: Recovery Gains Momentum

As the middle of the year approached, the landscape began to change. Many battered small-cap stocks had dropped to levels that attracted savvy buyers looking for value. Earnings reports released for the quarter ending March gave the market something to cheer — several companies exceeded expectations, sparking renewed interest across retail and institutional investors alike.

This rebound was also bolstered by a softer inflation outlook, a clear signal from the central bank to support growth, and easing crude oil prices — factors that shifted the mood from caution to optimism. Notably, the small-cap index surged more than 20% in the second quarter alone, highlighting the strength of this recovery phase.

The Stars of the Comeback

Some companies led the charge in this turnaround. For instance, Yatra Online clawed back from early losses to soar 78%, doubling investor confidence in a short span. Netweb Technologies mirrored this meteoric rise, while SPEL Semiconductor and Knowledge Marine Engineering posted gains well over 60%. Other notables like Aditya Vision, Swelect Energy Systems, and KIOCL contributed to the rally with double-digit recovery percentages.

The automobile segment drew attention with Force Motors delivering an eye-popping 110% return, attracting mutual fund interest. Infrastructure and specialty firms like Ashoka Buildcon, Swaraj Engines, Symphony, Firstsource, Laurus Labs, and Cyient capitalized on favourable sector trends to outperform considerably. Lesser-known counters also gained momentum, helping widen the rally’s breadth.

Why the Turnaround?

Behind this resurgence lies a blend of improving profitability, strong capital inflows, and policy support. Even when price movements seemed modest, profits across many small-cap companies surged impressively, with a majority posting robust returns on capital employed — a strong indicator of business strength.

Mutual fund data reveals growing investor confidence, with small-cap funds attracting substantial inflows, sometimes exceeding those into bigger segments. This shows that participants believe in the growth prospects of smaller firms despite inherent volatility.

Supportive macroeconomic factors, including accommodative monetary policy and easing commodity costs, created a fertile ground for recovery. Retail investors, helped by these factors and improved corporate earnings, began adding to their portfolios, reinforcing the positive momentum.

Staying Grounded Amid Optimism

While the rally has been heartening, caution remains vital. Valuations remain high relative to historical norms, which means further gains depend heavily on consistent earnings growth. Experts advise investors to focus on quality businesses with solid fundamentals rather than chasing quick gains. Stock-specific selectivity, rather than broad market bets, is viewed as the prudent path forward.

Key Takeaways for Investors

The small-cap segment’s journey this year serves as both a warning and inspiration. Volatility and corrections are part and parcel of investing in higher-risk stocks, but patience and discipline can lead to rewarding outcomes. With global uncertainties, policy moves, and investor sentiment all playing their roles, small-cap investing requires a balanced outlook combining growth ambition with risk management.

Ultimately, the comeback of well-chosen small-caps highlights the immense wealth-building potential they hold for those willing to look beyond short-term turbulence. Disciplined investors who do their homework and stick to fundamentally sound companies stand to benefit the most in India’s evolving growth narrative.