Key Takeaways
- • S Naren, executive director and chief investment officer of ICICI Prudential Asset Management Company, recommends avoiding systematic investment plans (SIPs) in small-cap and mid-cap mutual funds, citing valuations described as "absurd" as of January 25, 2025.
- • Median price-to-earnings (P/E) ratios for mid-cap and small-cap segments have both reached 43, representing extreme valuations compared to historical levels dating back to 2013-14 when these segments were trading at depressed valuations.
- • Market cap contribution in small and mid-cap segments significantly exceeds profit-after-tax (PAT) contribution, signaling a fundamental disconnect between market capitalization and earnings generation.
- • Momentum indicators for both mid-cap and small-cap indices have deteriorated recently, with both segments breaking below daily moving averages, suggesting early signs of momentum reversal after sustained strength.
- • Naren expressed bullish sentiment on large-cap equities and India's macroeconomic environment while flagging risks in the initial public offering (IPO) market.
Summary
S Naren, a senior investment executive at ICICI Prudential Asset Management Company, delivered a cautionary assessment of small-cap and mid-cap mutual fund valuations on January 25, 2025, at an event organized by IFA Galaxy, an association of mutual fund distributors. His primary recommendation: investors should halt SIPs in these segments and consider redeeming existing positions due to what he characterized as unsustainable valuation metrics.
Naren grounded his argument in comparative valuation analysis spanning over a decade. He noted that in 2013-14, small and mid-cap equities traded at depressed valuations, but since then valuations have compressed to extremes. The median P/E ratio for mid-cap stocks currently stands at 43, mirroring the valuation compression seen in small-cap indices, which also exhibit a median P/E of 43. Naren emphasized these multiples represent "absurd" levels relative to historical precedent, suggesting investors may be overlooking fundamental valuation discipline in pursuit of India's growth narrative.
Beyond valuation multiples, Naren examined the relationship between market capitalization and profitability in these segments. His analysis revealed that market cap contribution substantially exceeds PAT (profit-after-tax) contribution across small and mid-cap indices, indicating that market prices have expanded faster than underlying earnings generation—a classic indicator of excessive valuation. This disconnect persists even after accounting for India's elevated growth trajectory, which some market participants cite as justification for premium valuations.
Momentum analysis reinforced the bearish technical assessment. Naren consulted with a momentum specialist colleague who identified recent weakness in both mid-cap and small-cap momentum relative to the Nifty benchmark. Both segments have recently broken below their daily moving averages—a development that occurred within the preceding month. While Naren acknowledged this momentum deterioration may be early in cycle, he noted it represents a decisive technical breakdown after sustained upside momentum.
Contrasting his small and mid-cap stance, Naren expressed confidence in large-cap equities and India's macroeconomic fundamentals, though he flagged emerging risks within the IPO market warrant investor scrutiny.
Naren grounded his argument in comparative valuation analysis spanning over a decade. He noted that in 2013-14, small and mid-cap equities traded at depressed valuations, but since then valuations have compressed to extremes. The median P/E ratio for mid-cap stocks currently stands at 43, mirroring the valuation compression seen in small-cap indices, which also exhibit a median P/E of 43. Naren emphasized these multiples represent "absurd" levels relative to historical precedent, suggesting investors may be overlooking fundamental valuation discipline in pursuit of India's growth narrative.
Beyond valuation multiples, Naren examined the relationship between market capitalization and profitability in these segments. His analysis revealed that market cap contribution substantially exceeds PAT (profit-after-tax) contribution across small and mid-cap indices, indicating that market prices have expanded faster than underlying earnings generation—a classic indicator of excessive valuation. This disconnect persists even after accounting for India's elevated growth trajectory, which some market participants cite as justification for premium valuations.
Momentum analysis reinforced the bearish technical assessment. Naren consulted with a momentum specialist colleague who identified recent weakness in both mid-cap and small-cap momentum relative to the Nifty benchmark. Both segments have recently broken below their daily moving averages—a development that occurred within the preceding month. While Naren acknowledged this momentum deterioration may be early in cycle, he noted it represents a decisive technical breakdown after sustained upside momentum.
Contrasting his small and mid-cap stance, Naren expressed confidence in large-cap equities and India's macroeconomic fundamentals, though he flagged emerging risks within the IPO market warrant investor scrutiny.
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