Summary of this article
SMID valuations cooling but still above long-term averages
Post-COVID re-rating pushed multiples to historic highs
Further de-rating possible if market capitulation occurs
After nearly a decade of steady re-rating, valuations in small and midcap (SMID) stocks appear to be cooling off. According to a study by DSP Asset Managers (AMC), SMID valuations have “begun to normalise from an expensive zone”, raising the question of whether a longer phase of de-rating may now be underway.
The DSP study looked at the median trailing twelve-month P/E (price to earnings) ratio for small and midcap stocks over more than two decades. Historically, SMID valuations have been cyclical. According to the data, during periods of stress and bear markets, earnings multiples have corrected sharply. As the study notes, “the median earnings multiple for small & mid cap stocks craters during bear markets.” In earlier cycles, these corrections pushed valuations down to low or mid single digits, phases that later turned into strong long-term opportunities for investors.
The recent cycle, however, the study shows, has been very different. The re-rating that began after COVID pushed valuations to unprecedented levels. The median SMID multiple climbed steadily and peaked at around 46x, far above historical norms. Even after the recent correction, valuations remain elevated. The current median multiple is around 36x — lower than the peak, but still well above long-term averages, notes the study.
For context, the long-term median valuation for the SMID universe stands at about 20x. The study points out that this same 20x multiple would have looked “highly inflated” in 2007, but today it represents the long-term average. This highlights just how far valuations had stretched in the recent rally.
The data also shows how earlier peaks were followed by sharp corrections. For instance, in 2007, median valuations touched 20x before falling sharply during the global financial crisis. In 2017, SMIDs again re-rated to about 29x, which then cooled off in subsequent years. (Look at the chart below.) During the COVID crash of 2020, valuations briefly fell to around 15x before beginning another strong re-rating phase.
DSP AMC flags that if markets were to see a more severe capitulation, valuations could compress further. As the note cautions, “if the market undergoes a capitulation event, rising earnings and panic selling bring these multiples to levels at which SMIDs become bargain buys.” For now, though, valuations are still above average, even after the recent de-rating.
To summarise the broader message from the data, SMID valuations are no longer at their peak, but they are yet to return to historically attractive levels. Whether this normalisation turns into a deeper correction will depend on how earnings and market sentiment evolve from here.
