The persistent raising of concern by SEBI of froth in the small-cap segment has led to bloodbath in the small-cap space for the second day in a row with BSE Small-Cap index crashing 923 points and Nifty Small-cap 250 slipping by 298 points.

Of the 985 stocks in BSE Small-cap index, 845 stocks ended in the red while 215 stocks of Nifty Small-cap index was down compared to their previous close.

Madhabi Puri Buch, Chairman, SEBI on Monday raised concerns over stretched valuations of small- and mid-cap stocks, which are generally favoured by retail investors and have continued to enjoy their patronage through monthly purchase mandates to mutual funds built around such investment themes.

A few analysts have pointed to sudden fall in small- and mid-cap space to the stress test of mutual fund schemes investing in these stocks.

The Association of Mutual Funds in India has asked fund houses to conduct stress tests on their mid- and small-cap schemes based on last month data and disclose the findings before March 15. The stress test will ascertain the time frame taken to sell 50 per cent and 25 per cent of the small- and mid-cap portfolio without eroding the gains accrued. “The sell-off could be due to the rejig of portfolio by the mutual fund houses,” said an analyst.

Playing spoilsport

Manish Chowdhury, Head of Research, StoxBox said the double whammy of profit booking and nervousness due to increased regulatory scrutiny has poured cold water on the dream run of small cap stocks. Though it is difficult to time the market, he said investors should not worry about small-cap companies that have reasonable valuation and revenue visibility.

Rahul Ghose, CEO, said it is advisable for investors to lighten exposure to this sector as overall the Nifty PE has entered into the expensive zone beyond the 22-mark. Moreover, he said the mid- and large-cap indices are not falling as much as small-cap which further reiterated the warning sign.

Stock-specific approach

Shrey Jain, Founder & CEO, SAS Online, a deep discount stock broker, said investors in small-cap space should take stock-specific approach to avoid major draw-downs. “The fall in market can be used to accumulate such domestic economy-focused companies that are quoting at fair valuations after the recent dips,” he added.

Nikunj Saraf, Vice-President, Choice Wealth said an analysis of the current valuation levels in small-cap space indeed underscores SEBI’s apprehensions about a potential bubble forming in mid-cap and small-cap stocks, underscoring the necessity for heightened vigilance.

The Smallcap 250 index currently trades at about 22 times earnings per share on a one-year forward basis which is nearly 50 per cent premium compared to valuations observed about March 2018 levels. The recent decline in the small-cap index over the past two days serves as a clear indication of the potential risks lurking for investors, he added.