Small and mid-cap stocks are turning red-hot with the Narendra Modi-led NDA government forming government for the third consecutive terms.

While the run-up in small-cap stock price has been giving sleep-less nights for regulators, the earnings of small companies have also been rising steadily with the increase in flow of fresh orders, better execution and availability of funds at reasonable cost.

The earnings per share of NSE Small-cap 100 index has jumped more than four times last fiscal to ₹598 against ₹145 in FY21.

The EPS of NSE Mid-cap 100 index has zoomed two times to Rs 1,462 last fiscal against ₹566 in FY21.

However, too much of money chasing these mostly illiquid stocks has been a major concern. Valuations of small and mid-cap stocks are rising much faster than the large-cap due to potential returns they can deliver.

The share of mid and small stocks in the country’s total market capitalisation was 36 per cent last month compared to 25 per cent December 2020 and 20 per cent in December 2013, said an ICICI Prudential MF report. Meanwhile the contribution of the large caps declined to 64 per cent in May compared to 74 per cent in December 2020 and 80 per cent in 2013.

While Nifty rose 26 per cent and 16 per cent over last one and three years, the Nifty Midcap 150 has returned 57 per cent and 28 per cent in the same period. The Nifty Small cap 250 had jumped 62 per cent and 27 per cent, respectively.

Nirav Karkera, Head Research, Fisdom said small and mid-cap valuations, at headline levels, may seem stretched at the moment, but there are several pockets in this segment that present a solid case for an earnings upgrade and valuation re-rating on the back of a robust growth outlook.

“There should be limited concerns around retail participation as long as their investment decisions are based on thorough research or outsourced to a credible fund manager having established track record in navigating the space,” he said.

Nikunj Saraf, Vice President, Choice Wealth said investors are advised not to sell their small and mid-cap stocks just yet, as there is growth momentum.

However, cautious approach is necessary as high entry valuations may limit future upside potential, he added.