Edited excerpts from a chat:
How do you look at the growth trajectory of niche and specialised businesses in the smallcap space? Any particular sectors that you like within them?
The growth trajectory for niche and specialised smallcap businesses remains attractive, but it is uneven. These companies are typically addressing very specific gaps—components, processes, or services—rather than broad end markets. When execution is right, this allows them to grow faster than the economy for extended periods, without immediately running into scale constraints.What matters most here is not the niche itself, but three things: longevity of the opportunity, the company’s ability to reinvest capital at high returns, and balance-sheet discipline during the growth phase. Many smallcaps fail not because demand disappears, but because capital allocation or leverage goes wrong while scaling.
Our approach to investing even in the niche and specialised businesses remains extremely bottom-up. We focus on understanding the durability of the business model, competitive positioning, capital intensity, and management’s approach to scaling the business. Growth by itself is not sufficient in the small-cap space. We look for growth that is accompanied by improving or sustainable margins, healthy cash-flow conversion, and return ratios that justify reinvestment. Businesses that can compound while maintaining balance-sheet discipline and capital efficiency tend to create long-term value, while those that chase growth without financial rigor often struggle over a full cycle.
While the outlook for mid and largecaps have improved, smallcaps as a whole is seen as lagging behind – both in terms of earnings growth as well as share price performance. What should smallcap investors do at this stage?
Smallcaps have often gone through phases of consolidation after periods of strong outperformance, historically. What we are seeing over the last year—both in terms of price correction and earnings moderation—fits into that pattern rather than being an anomaly.
Periods of excess optimism in this segment are usually followed by phases where valuations and fundamentals realign. That is the nature of the segment, and investors should approach it with that understanding.
From an investor’s perspective, small caps continue to remain one of the most effective ways to participate in India’s economic transformation. Many of the changes playing out across sectors and industries are being driven by companies that sit in this part of the market.
That said, short-term volatility is unavoidable. Small-cap investing works best when viewed through a longer-term lens. Given their role in long-term wealth creation, allocations to small caps should be made with an adequate time horizon and the ability to stay invested through interim volatility.
From an earnings perspective, do you think smallcaps will begin to report healthy growth from FY27?
Earnings visibility for small caps does improve as we look toward FY27, but the confidence comes less from near-term cyclical factors and more from the structural changes in the operating environment. India’s economic transformation has materially altered how small businesses operate—access to capital and talent is deeper, supply chains are more formalised, governance standards have improved, and the ability to scale across markets is significantly better than in the past.
However, this does not imply a uniform earnings recovery across the segment. Small-cap earnings cycles are inherently uneven, and outcomes tend to be driven by company-specific execution rather than macro conditions alone. We believe the next phase of growth is therefore likely to be selective rather than broad-based.
Crucially, where earnings do improve, we believe the quality of growth should be stronger. Profitability is more likely to be driven by operating leverage, margin normalisation, and better cash-flow conversion. This makes bottom-up stock selection essential, as only a subset of companies, we feel, will be able to translate the improving structural backdrop into sustained and high-quality earnings growth.
A lot of investors are still not comfortable with valuations in the smallcap space. How about you? There’s no froth at a broad level but the valuations don’t look cheap either. The small-cap universe is highly fragmented and heterogeneous. How critical is bottom-up stock selection in this segment, and what are the non-negotiable filters you apply while evaluating businesses at this end of the market-cap spectrum?
Valuations in the small-cap space today need to be viewed with nuance. At a broad level, there has been a moderation, but valuations are not uniformly favourable. The small-cap universe is highly fragmented and heterogeneous, which makes aggregate valuation metrics less meaningful. You can find pockets of excess as well as areas where growth and earnings potential are still reasonably priced.
This makes bottom-up stock selection critical to this segment — outcomes are driven far more by company-specific execution than by market-level trends. A broad-brush approach can very easily dilute quality and increase risk.
As far as our small cap investing philosophy is concerned, we place greater emphasis on growth, as these businesses typically have longer runways and are earlier in their lifecycle. Valuations, therefore, can be somewhat flexible—but only within defined comfort levels and supported by earnings visibility. What we absolutely do not compromise on is quality—both in terms of the business model and the management running it.
These principles are embedded in our bottom-up QGaRP framework, which balances growth potential with quality and reasonable valuation. This is also how we are approaching the Groww Small Cap Fund, currently open for subscription—remaining true to label, selective in exposure, and focused on building a portfolio that can compound over a full market cycle rather than chase short-term re-rating.
Overall, do you think 2026 would be better for smallcap investors after a painful 2025?
2026 does look more constructive for small-cap investors compared to 2025, largely because expectations are now more realistic. A lot of the excesses in various pockets have been corrected.
That said, a straight-line recovery should not be expected. Small caps may continue to be volatile, and performance is likely to be selective rather than broad-based. However, as earnings visibility improves and fundamentals begin to assert themselves, the environment becomes more supportive for bottom-up, quality-focused investing.
For long-term investors, we believe this phase can be meaningful. Small caps remain an important way to participate in India’s economic growth, and periods following consolidation have historically presented attractive entry points for long-term investors.