Small-Cap Vs Large-Cap Stocks: Understand The Risk, Returns And Valuations

In a previous edition of Outlook Money (May 2024), we mentioned the rally in small-cap stocks, which was larger in proportion than in large-cap stocks. We had cautioned investors about investing in small-cap stocks or funds. Since then, a correction has taken place. It began after September 2024, and happened across large-, mid- and small-cap stocks; however, the proportion was higher in small caps (see Index Performance From 2024 Peak To 2025 Trough).

From the trough, the recovery has been stronger in small caps than in large caps. This is leading to higher retail participation in small-cap stocks and funds (see Trough To Recovery In 2026). Clearly, small caps have been more volatile on both sides.

Market Cap And AUM

The response from retail investors to the recovery in small-cap funds has been more than proportionate.

At the end of July 2026, the assets under management (AUM) of large-cap funds was Rs 4.16 lakh crore. On the same date, the AUM of mid-cap funds was Rs 5.23 lakh crore and small-cap funds was Rs 4.41 lakh crore. Hence, the combined AUM of small and mid (SMID) cap was Rs 9.64 lakh crore, which is 2.32 times of the large-cap AUM. Three years ago, as of July 2023, it was Rs 4.12 lakh crore in SMID and Rs 2.66 lakh crore in large caps, making the SMID AUM 1.55 times of the large-cap AUM. As the multiple shows, the AUM has seen a significant run-up.

The Association of Mutual Funds in India (Amfi) data on market capitalisation shows that in the six months ended June 2026, the total market cap of large-cap stocks was Rs 275 lakh crore, against Rs 94 lakh crore for mid caps and Rs 93 lakh crore for small caps. The combined market cap of SMID (Rs 187 lakh crore) is 68 per cent of the large-cap market cap.

To put it simply, the AUM of SMID funds is more than double (2.32 times), but the market cap of SMID funds is much lower than that of the large-cap stocks. This indicates there is a skew in terms of investor preference for SMID over the last three years.

This is reflected in the number of folios as well. In July 2023, the number of folios stood at 13 million in large caps, 11.3 million in mid caps, and 13 million in small-cap funds. Hence, the combined number of folios in SMID was 1.87 times that of large caps. In July 2026, 17.1 million folios were in large caps, 25.9 million in mid caps and 29.2 million in small caps. The combined number of folios in SMID was 3.2 times of large-cap funds. The run-up from 1.87 times to 3.2 times shows the pull factor of small caps over the last three years.

In a way, it is good as long as the horizon is long enough and people are creating wealth. It is good for the MF industry as well. However, return expectations must be realistic.

Valuation

For valuation, we will look at the price-earnings (P-E) and price-to-book-value (P-B) multiples. As on August 14, 2026, the P-E ratio of Nifty 100 stocks (trailing basis) was 20.42, and the P-B ratio was 3.05, according to NSE. On the same date, the P-E ratio of Midcap 150 stocks (trailing basis) was 29.91, and the P-B ratio was 4.47. For Nifty Smallcap 250 stocks, the P-E and P-B ratios were 34.05 and 3.6, respectively.

Let’s look at one more category: Nifty Microcap 250, which includes the top 250 companies beyond the Nifty 500 index constituents. It’s P-E and P-B ratios were 28.14 and 3.57, on August 14.

So, there is a stretch on valuations, at least going by the trailing P-E ratios. It is 20.42 for large caps, 29.91 for mid caps, and 34.05 for small caps 250. The limited market cap of SMID (68 per cent of large-cap stocks) is being chased by a larger pool of money (2.32 times).

While there are other investors in the market, MFs are major participants and the run-up is a broad-based one (see Decent Performance Over 5 Years, Till July-End 2026). There is a differential in performance, and that is the nature of markets. Over 5 years, mid- and small-caps have performed better than the large caps.

Now, contrast the 5-year decent performance with muted 1-year performance till March 23, 2020, when the market went through pre-Covid correction (see Comparative Returns).

History shows that small-cap stocks and funds tend to be more volatile than large-cap ones. We saw a similar phenomenon between 2024 and 2026, as mentioned at the start of this article.

Conclusion

The growth story of India remains intact and there is a case for diversification to mid- and small-cap stocks in your portfolio. Having said that, investors should bear in mind:

• Returns from SMID in a superlative phase may not be repeated next year.

• Allocation in your portfolio should be driven by logic, not by market movement.

• Volatility is part of the game, and at stretched valuations, the probability of volatility is higher.

By Joydeep Sen Corporate Trainer and Author