Small and midcap stocks may deliver subdued returns over the next five years, with potential gains falling below 5%, according to a strategy note by Nuvama Wealth Management. The brokerage has raised concerns over elevated valuations and a weak earnings outlook, even as the segment has rebounded to pre-war levels in April 2026.

While recent gains have lifted investor sentiment, Nuvama cautioned that price strength is not supported by equally strong fundamentals, indicating limited upside potential from current levels.

Key Highlights

• Nuvama warns small and midcap stocks may deliver below 5% returns amid elevated valuations, weak earnings outlook.
• Liquidity supports SMIDs, but earnings risks, valuation premium likely keep markets range-bound without strong triggers.

The brokerage highlighted that valuations across small and midcap stocks remain significantly above long-term averages. The BSE SmallCap and Midcap 400 index is trading at nearly 4x price-to-book value, compared with a historical average of around 2.8x.

In addition, small and midcap stocks are currently trading at about a 40% premium to large-cap stocks, well above the long-term average of nearly 20%, indicating stretched pricing. Nuvama added that similar valuation levels in the past have typically resulted in muted five-year returns, often staying below 5%.

The report also flagged concerns over earnings projections, with consensus estimates suggesting around 22% annual profit growth between FY26 and FY28. However, Nuvama believes the current macroeconomic environment does not support such optimistic expectations. Weak household income growth, slowing corporate capital expenditure, and limited government spending capacity are likely to weigh on earnings momentum. “Sharp rebound a la Covid-19 or the Russia-Ukraine war is unlikely,” the brokerage said.

The report further noted that credit growth is being driven by segments like gold loans and small business lending, which may not generate broad-based economic expansion.

Nuvama expects the SMID segment to remain range-bound in the near term, with indices moving within a defined band over the past two years. “Expect SMIDs to be range bound until fresh stimulus arrives or valuations turn cheap,” the report said. This suggests that without strong policy triggers or earnings upgrades, markets may struggle to sustain a breakout rally.

Another key concern highlighted in the report is the gap between equity and fixed income returns. Nuvama pointed out that earnings yield for SMIDs is around 4%, compared to India’s bond yield of about 7%, making equities relatively less attractive. This is a historical anomaly, the brokeragereferring to the unusual gap between earnings and bond yields. Such a scenario is typically seen during strong growth cycles, which are currently absent.

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Despite its cautious stance, Nuvama acknowledged that strong domestic institutional investor (DII) flows and ample liquidity continue to support the market. “Easy liquidity, sustained DII flows, and strong SMID balance sheets would preempt a breakdown,” the report added.

These factors may help limit downside risks, even if upside remains constrained.

Nuvama recommends a bottom-up stock selection approach, focusing on companies with strong cash flows, improving margins, and consistent reinvestment. The brokerage sees relatively better opportunities in consumption-driven and export-oriented sectors, compared to capital expenditure-heavy segments. “We find attractive bottom-up ideas, especially in consumption and exports,” the firm said.