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ETMarkets Smart Talk | Large caps look better for next 24 months, but hidden gems remain in smallcaps: Divam Sharma
Divam Sharma, Co-Founder and Fund Manager at Green Portfolio, believes the market is entering a phase where earnings, rather than valuation re-rating, will be the key driver of returns. With the Nifty trading around its long-term valuation average, he expects low-to-mid teens returns over the next 2-3 years if earnings deliver.
Sharma sees a stronger case for large caps over the next 24 months, particularly given the steep valuation premium commanded by small caps.
However, he believes investors should not dismiss the smaller end of the market altogether, as pockets of genuine mispricing remain among companies with real cash flows, strong promoters and limited analyst coverage.
For him, the opportunity is less about choosing between large and small caps and more about identifying businesses where growth expectations are not already fully priced in. Edited Excerpts –
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Q) Market showing signs of stability. How do you read it?
A) The market has stopped falling. It has not started running. Recovery in small caps has been good so far so was their fall in FY26.Nifty peaked at 26,373 in January, fell to 22,182 — nearly 16% — because a war shut the Strait of Hormuz and crude went through the roof. Today we are back at 24,395.
Three things steadied us: crude has cooled from $110 to $87, June-quarter results were better than feared, and the RBI on 5 August held rates, raised its growth forecast and cut its inflation forecast.
But the real story is who owns this market. Foreigners sold roughly ₹3.4 lakh crore in six months. Indians bought ₹4.5 lakh crore.
With geopolitics seeing stability, US India relation easing, EU FTA coming into effect soon – FII money inflow can pick up (it has already improved since June 2026).
Q) Household debt at ~48% of GDP. Is consumption now credit-dependent?
A) The number is right, and I’d argue it’s if anything on the low side.
RBI’s official figure is 45.5%. But that’s already stale. Gold loans jumped from ₹3.16 lakh crore in September 2025 to ₹4.89 lakh crore by April 2026 — 55% in seven months. So, 48% today is fair.
Is 45–48% dangerous by itself? No. Thailand and China are higher. The problem is not the size of the debt. It is the purpose of it.
Look at what people are actually borrowing. Fintechs now dominate small loans below ₹50,000, and the average ticket is ₹16,238. That is not a wealth-creating loan. That is white goods, phone and daily use items.
And the line that worries me most: RBI says the gold-loan surge is mostly existing borrowers using higher gold prices to borrow more — often to repay old loans. When a family refinances with gold instead of income, that is not consumption. That is stress.
Meanwhile rural wages are growing about 4% — the weakest in four years.
Thirty years has taught us one thing: every credit accident in India — 2007, 2018 — happened while the overall number still looked fine. The average tells you nothing. The marginal borrower tells you everything.
Q) Should returns now come from earnings rather than re-rating?
A) Yes. And let’s go further — assume zero re-rating. If it comes, treat it as a bonus, never as the reason you bought.
Nifty is at about 20.6x earnings against a long-term average of 20–21x. Fairly valued. Not cheap, not expensive.
When you start at fair value, your return is earnings growth plus dividend. There is no third source of money.
Here’s history worth remembering. Between 2003 and 2007 the Sensex went up five times, and everyone calls it a great re-rating. It wasn’t. Company profits went up nearly four times. The multiple did barely a quarter of the work.
That is the healthy kind of bull market.
The other kind — where the P/E does the heavy lifting — always asks for the money back, usually at the worst moment.
My honest expectation: low-to-mid-teens returns over 2–3 years if earnings deliver. Every rupee has to be earned. That is a far better market for stock-pickers than for index buyers.
Q) Earnings outlook after Q1? Can upgrades become a catalyst?
A) Q1FY27 was the first genuinely good surprise after a long time.
The street expected profits to fall but it rose. Strip out the oil marketing companies and earnings grew 17%. Banks grew 20%, metals 53%. Small caps grew earnings 32%. And notice — the weak spots were cost problems, not demand problems. The OMCs absorbed the crude shock on the country’s behalf.
But the most important line in the whole results season was quieter: downgrades have slowed.
The sequence never changes. Downgrades stop → estimates settle → upgrades begin → market rises. We are between step two and three. Not step four.
So we should hold back on celebration. The street is already building in massive EPS growth for FY27. Upgrades matter when they are delivered, not when they are forecast.
Everything hangs on one thing — crude. Simply:
• Brent at $75–80 → real upgrades by Q3, this becomes a proper earnings market
• Brent at $85–95 → growth trims, market grinds sideways
• Brent above $100 → we retest the lows
Until September and December results settle it: own earnings you can already see, not earnings that need a peace treaty.
Q) What brings FIIs back decisively?
A) The rupee first. Then oil. Then earnings. Valuations last — and I say that deliberately, because most people put it first.
Think from a foreigner’s chair. The rupee fell 11% in a year, to about ₹96 making it lucrative to bring fresh dollars.
Then oil, because to a global investor India is basically a bet against crude.
Valuations come last because India has always been expensive. Nobody ever bought this market because it was cheap. They buy it when growth and currency work together.
And the turn has started — ₹20,200 crore in July, another ₹12,900 crore in the first week of August – FII inflow.
Let’s hope this sustains.
Q) How much of India’s premium over other emerging markets is justified?
A) India trades around 20–22x against 12–14x for emerging markets — a premium of roughly 60–70%. Sounds high, but our own long-run average is 55–60%, and in mid-2024 it hit 104%. So the premium has already compressed sharply.
What justifies it: nominal GDP growing 10–11%, better returns on capital, and a domestic investor and consumer base no other emerging market has. ₹31,961 crore of SIPs a month, and Indian equity funds have seen 63 straight months of inflows — right through the war. That deserves a premium, because it permanently lowers the cost of capital for Indian companies.
But there are pockets where there’s too much optimism. Anything sold on a “ten-year story.” Parts of new-age tech, some EMS, quick commerce. The order books are real. The margins are not proven. When you pay 60–80x FY28 earnings, you are demanding five years of flawless execution with no competition and no fundraise. That has rarely happened in Indian corporate history.
Also, small caps as a class, and FMCG, which has been priced for a volume recovery that has been “many quarters away”.
Where the market is too pessimistic: the oil-sensitive lot — OMCs, aviation, paints, tyres, chemicals — priced as if $100 crude is permanent. And IT, where AI fear is fully in the price but the benefit of a ₹95 rupee is barely counted.
I have heard “India is expensive” every single year since 1996. Anyone who sat out on that basis missed a thirty-year compounding story. Expensive alone doesn’t kill you. Expensive plus no earnings growth kills you. Watch the second one.
Q) Which sectors can beat the market on earnings over 2–3 years?
A) There are many such sectors, and I’ll be honest about which are structural and which are just cyclical.
Power, transmission and grid equipment — government capex, rising electricity demand, data centres on top. The cleanest 20%+ growth available, and it doesn’t depend on the consumer’s mood.
Defence and defence electronics — private order books have gone from ₹40,000 cr to an estimated ₹55,000 cr. But the bigger point is that the war moved procurement from committee timelines to emergency timelines. That’s a decade, not a quarter.
Capital goods and EPC tied to government spending. Telecom — three players, real pricing power for the first time in a decade. Pharma and CDMO — China de-risking, and at ₹95 every export rupee is worth more.
Metals — up 53% last quarter. But be clear: that’s supply disruption. Trade it, don’t marry it.
Underweight: staples, where growth is only price increases; two-wheelers and rural discretionary if wages stay at 4%; and any sector which survives only if crude remain low.
Read more: ETMarkets Smart Talk | India enters earnings-led phase; Anil Rego favours financials, autos, industrials
Q) Is rotation into reasonably valued large caps the dominant theme?
A) On merit, yes. In terms of where money is actually going, no — the opposite. And that gap is the most interesting thing in this market.
Look at July’s flows. Small-cap funds got ₹7,768 crore. Mid-caps ₹6,192 crore. Large-cap funds saw an outflow. Retail money is still travelling down the size curve, not up.
Foreigners, who have just started buying, always begin at the top with liquid large names. So the two big buyers are pulling in opposite directions.
On valuation, large caps should win the next 24 months. Nifty is at 20.8x, Smallcap 250 at 35.5x — small caps are demanding a 71% premium for earnings that are more volatile, less researched and much harder to sell.
But let me reframe the question. It isn’t large versus small. It’s priced-in versus not-priced-in. There are large caps expensive for their growth and small caps genuinely cheap for theirs. At Green Portfolio we still find more mispricing in the ₹2,000–15,000 crore range — real cash flows, promoters we can sit across the table from, no analyst coverage — than in the Nifty 50.
One memory for your readers. In early 2018 everyone “knew” large caps were safe and small caps were frothy. The rotation did happen — Nifty made new highs while the small-cap index fell nearly 40%. But it took two full years and exhausted almost everyone’s patience. Rotations in India are slow, then violent. Never smooth.
Q) How worried are you about valuation and liquidity risk in mid and small caps?
A) Worried in pockets, not everywhere — and the difference between mid and small now matters a lot.
Mid-caps have normalised: Nifty Midcap 150 at 30.2x is roughly in line with its five-year median. Small caps have not: Smallcap 250 at 34.4x is about 22% above its median.
But let me separate two things’ people constantly confuse.
Valuation risk costs you time. Liquidity risk costs you money. Overpay for a good business and you wait three years for earnings to catch up. Own an illiquid business into a redemption wave and the price detaches from value for months — because the exit door is the same size for everybody.
Now add supply. FY26 saw 108 IPOs raise ₹1.76 lakh crore, with PE-backed listings rising to 35% of issuance. Read that plainly — promoters and PE funds are selling, retail is buying. That transfer always tells you where you are in the cycle.
Three rules we follow, and any investor can copy them:
1. Size your position to liquidity, not to conviction. However, much you love the business.
2. Demand cash flow, not just profit. In a squeeze, what breaks is the company funding growth on debt and stretched receivables. Profit is an opinion. Cash flow is a fact.
3. Accept that quality won’t save you in the first three months of a fall. It saves you in the recovery.
January 2018 is the lesson I keep going back to. The small-cap index peaked and didn’t recover until late 2020.
Most people who lost money there did not own bad companies. They owned good companies bought at the wrong price with borrowed patience. The businesses survived. The investors didn’t stay.
(Disclaimer: Recommendations, suggestions, views, and opinions given by experts are their own. These do not represent the views of the Economic Times)
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