The fast and furious multibagger party in smallcaps has left investors with a valuation hangover. While the Nifty SmallCap 100 is trading at a price-to-book (P/B) value of 6.7 which is the highest since FY13, at least 128 smallcap multibaggers are trading above their 5-year average price-to-earnings (PE) level.

An analysis of multibagger stocks with a market capitalization of at least Rs 500 crore but less than Rs 10,000 crore reveals 128 names like Rajoo Engineers (up 721%), Piccadily Agro (661%), Cupid (623%), KP Energy (578%), Shilchar Technologies (556%) and Magellanic Cloud (455%) that are above average valuations, shows data from ACE Equity.

Shares of Oriental Rail Infrastructure, which has rallied 341% in just one year, are trading at TTM PE of 79 against a 5-year average of 31. Similarly, eight-bagger Rajoo Engineers is trading at 78.6x against the historical average of 17.4.

Others in the list include HPL Electric & Power, Apollo Micro Systems, Sandur Manganese & Iron Ores, Genus Power Infrastructures, Salasar Techno Engineering, Pakka, Mishra Dhatu Nigam, VA Tech Wabag, Praveg and Saksoft.

At a PB level, Nifty SmallCap 100 is currently trading at 149% of its historical valuation surpassing its previous peak of 125% made in FY21, calculations done by HDFC Securities shows.

“70% of the constituents of the index are trading at a premium to their historical valuations indicating the broad-based richness of valuations. Previous peak was made in FY22 when 58% of the index constituents were trading above average valuations,” said Varun Lohchab of HDFC Securities.

Except for the media, every sector of the smallcap index is trading at a premium to their historical valuations with chemicals, consumer durables, energy, IT and BFSI being overheated sectors.

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This level of overvaluation and breadth has been seen only a few times in the past 20 years (2007 when 75% of Nifty constituents were overvalued relative to history) and to a lesser extent in FY15-17 (44% of midcap constituents overvalued) and FY21-22 (~46% of midcap constituents overvalued), Lohchab said.

The extent of overvaluation relative to history is the highest in smallcaps while on an absolute basis, the midcap index looks most overvalued.

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However, in a mega bull market the trend of stocks trading at a higher PE compared to their historical average is common. “We are seeing PE expansion as well as euphoric moves in midcap and smallcap spaces. Investors should not worry about this, but they are advised to remain nimble about the quality of shares because we will see some intermediate shakeout phases,” said Santosh Meena, Head of Research, Swastika Investmart.

The recent Q3 earnings season is adding to worries as the numbers of some of the PSU railways, defence and power stocks, do not justify such expensive valuations.

“We can take the example of IRFC and SJVN, which were multibagger stocks in recent times, but their earnings were disappointing. We then saw a sharp correction from higher levels, but PSU stocks are the leader of this bull run, and they are moving on India’s growth story and their order books. Therefore, their upside move is likely to continue, but there will be a time when this trend will reverse if the financials do not match the stock’s move,” Meena said.

Market history shows that this level of overvaluation in mid and smallcap indices has not always resulted in a sharp index correction in subsequent 1-2 years, but it leads to a subdued return in the next few years.

The valuation hangover could, therefore, be a headache-in-waiting for smallcap warriors.

(Data: Ritesh Presswala)

(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)

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