Analysis of Q3 earnings by brokerages show that growth was more pronounced in smallcaps compared to largecaps. “Most sectors saw acceleration with smallcaps being the clear outperformer. Earnings downgrades are moderating and upgrades should begin soon,” IIFL Capital said.
The brokerage maintained its January outlook that 2026 should see earnings upgrades, expect largecaps to deliver 15%+ returns from here, and smallcaps to outperform over the full year but with a lag. IIFL has expanded its list of smallcap top picks to include PB Fintech, Godrej Properties and Motherson Sumi Wiring—describing them as “our version of fallen angels.”
Nifty Smallcap 250 index is up around 4% this month after losing 5.5% of its value in January as the risk-reward is gradually improving, though recovery is expected to be slow and gradual through 2026. Near-term consolidation is likely, with market breadth remaining narrow, according to market observers.
Turnaround quarter for smallcaps?
“3Q FY26 is a turnaround quarter for the small cap universe in terms of growth given the base impact and recovery seen over last year,” said Sanjay Doshi, Head of Investments and Research at Abakkus Mutual Fund. However, he cautioned that “overall numbers may be a bit lower than expectations” due to visible impact of trade uncertainties in export-oriented segments and gradual domestic recovery.
“The improvement in the small-cap outlook post Q3 is largely being driven by an alignment between the earnings delivery and market sentiment,” explained Sorbh Gupta, Head – Equity at Bajaj Finserv Asset Management Limited. “While earnings growth in the small and mid-cap space was already improving, stock prices had not reflected this because of persistent negative sentiment, especially around global trade and tariff-related uncertainties.”
“With the recent US trade deal and improving visibility on capital flows, that sentiment is now narrowing. As a result, we believe stock price movements should increasingly track earnings growth, and in some cases even exceed it through selective valuation re-rating,” Gupta added.
Which stocks to buy?
Gaurav Bhandari, CEO of Monarch Networth Capital, identified financials, consumer discretionary and select capital-goods companies as sectors reporting better earnings, “supported by credit growth, sustained domestic spending and infrastructure-linked activity.” Manufacturing benefited from policy initiatives and rising capacity utilization, while consumer-facing segments got a boost from “Government push (rationalization of GST structure) to encourage consumption.”
“Further, the recent trade deal with EU & US has also improved the overall business prospects for small and mid-size firms which are significantly reliant on exports to developed economies,” Bhandari noted.
Gupta highlighted building materials (particularly cement), select metals and chemicals, banking and financials, consumption-linked names and healthcare as attractive pockets. “Cyclicals are seeing a clear improvement in outlook as demand visibility improves into Q4 and FY27, while liquidity support is also becoming more evident.”
Despite the improving picture, analysts urged selectivity. “There is quite a broad skew in company results within sectors across the small cap universe,” Doshi warned, with companies in EMS, chemicals, auto ancillaries, engineering and hospitality doing well, while textiles, food processing and discretionary consumption witnessed pressure.
“Smallcaps are still somewhat expensive at an index level,” IIFL Capital cautioned, while Bhandari advised a “bottom-up approach” focusing on “companies with sustainable business model, excellent corporate governance, good cash flows, high return ratios, superior capital allocation track record.”
While smallcaps are clawing their way back, investors need to pick their bets wisely as this is a stock-picker’s market and not a rising tide that lifts all boats.
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)