Given their large stakes in the pocket, ordinary investors are now more vulnerable as a result of the recent steep decline in smallcap stocks. According to Kotak, it is still unclear if the drop signifies a shift in the market's focus from sentiment and narratives to fundamentals and numbers. However, it cautioned that many low-quality stocks would still have a ways to fall if this is the first instance.

Certain small-cap companies are trading at high valuations based on consensus estimates, including KEI Industries, MRPL, Cochin Shipyard, NBCC, Birlasoft, Cyient, Zensar Technologies, IRB Infra, and Kalyan Jewellers. Global Health, Jyothy Labs, Glenmark Pharma, RITES, and CESC were among the others. These are the small cap firms that have at least five analysts following them. 

As of December 31, 2023, FPIs held 23.3%, 15.5%, and 12.1% of the NSE 100 index, NSE Midcap 100 index, and NSE Smallcap 100 index, while MFs held 9.4%, 10.4%, and 8.3% of the NSE 100 index, NSE Midcap 100 index, and NSE Smallcap 100 index.

Conversely, small cap companies have typically been preferred by retail investors. In December 2023, their stake in the NSE 100 index, NSE Midcap 100 index, and NSE Smallcap 100 index was 7.9%, 9.5%, and 15.4%, respectively, as compared to 7.5, 8.4%, and 12.5% in March 2019.

"It would appear that retail investors have taken a more positive view on small-cap stocks and a more active part in the rally in smallcap stocks and are thus more exposed to the ongoing correction," Kotak said.

Suzlon Energy, BSE, MCX, and HUDCO were some of the main drivers of the smallcap index's recent six-month surge.

The domestic brokerage believes that most midcap and smallcap stocks are priced excessively, particularly when considering their individual histories and business plans. 

"The recent correction in broader markets is quite small in the context of the large returns of the past year. The Nifty Midcap 100 Index and the Nifty Smallcap 100 Index are down 5 per cent and 10 per cent in the past one month but they are still up 53 per cent and 58 per cent, respectively, in the past one year," it said.

Sixty-one percent of mid-cap equities and sixty-three percent of small-cap stocks have returned more than thirty percent in the last year.