Smallcaps cheaper but not cheap yet: Sonam Srivastava urges selective investing

In this interaction, she explains why caution is still warranted in the smallcap space, outlines sectors offering better opportunities, and discusses portfolio strategies amid geopolitical uncertainty and volatile markets.

Edited excerpts from a chat:

Equity investors are now worried about the impact of the Iran war, which comes at a time when the market hasn’t provided any return in the last 18 months. What is the best solution to navigate this crisis, besides continuing SIPs?

Geopolitical events like the Iran conflict create short-term volatility but rarely alter long-term earnings trajectories. The real concern here is that flat 18-month returns have tested investor patience precisely when resilience matters most. Beyond SIPs, the best navigation strategy is tactical asset allocation, where you incrementally deploy idle cash into quality large-caps during sharp drawdowns rather than waiting for certainty.
Avoid panic-driven rebalancing. If your portfolio has drifted equity-heavy due to prior rallies, partial reallocation to short-duration debt provides both stability and dry powder. Geopolitical crises compress valuations temporarily but rarely compress earnings permanently. Investors who stayed disciplined through COVID, the Russia-Ukraine war, and rate hike cycles were rewarded. Volatility is the price of equity returns and not necessarily a signal to exit.

Live Events

How are you deploying cash across portfolios amid the decline in share prices? Which sectors are increasingly looking attractive from both growth and valuation perspectives for FY27?

The approach should be staggered and conviction-weighted. Rather than deploying cash in one tranche, spread it across 3–4 tranches over 6–8 weeks, prioritising sectors where earnings visibility remains intact.
Currently, large-cap private banks, select capital goods names, and pharma offer reasonable entry points. Avoid bottom-fishing in beaten-down small-caps without earnings support.

For FY27, sectors increasingly attractive on both growth and valuation include:

• private sector banking, which has seen credit growth recovery, NIM stabilisation
• healthcare/pharma with domestic formulations & US generics tailwinds
• infrastructure-linked capital goods with order book visibility
• Select IT services where AI-driven deal ramp-ups have occurred post a weak FY25
• Consumer discretionary also looks selectively interesting as rural demand recovers with a good rabi crop and potential tax relief transmission.

Overall, how cheap is the market considering that the Q3 numbers had a one-time impact from the Labour Code as well?

The Q3 earnings season was distorted. The Labour Code provisions created a one-time drag that artificially suppressed PAT margins across sectors like retail, hospitality, and manufacturing.

Stripping that out, underlying earnings were broadly in line. On a cleaned-up basis, Nifty trades at roughly 18–19x FY27 estimated earnings, which is close to long-term averages and not screaming cheap, but meaningfully off the frothy 22–23x seen in late 2024.

The broader market (mid and small-cap indices) has corrected 20–30% from peaks, bringing pockets of genuine value. The market isn’t dirt cheap, but it’s no longer pricing in perfection. For patient 3-year investors, current levels offer a reasonable margin of safety, particularly in financials and capex-linked themes where FY27 earnings recovery looks more credible.

How comfortable are you now regarding valuations in the small-cap space?

Comfort has improved meaningfully, but caution remains warranted. The small-cap index has corrected ~25–30% from its peak, compressing valuations from clearly excessive levels to something more reasonable.

However, “less expensive” is not the same as “cheap.” Many small-caps still trade at premium multiples relative to their earnings quality and growth predictability. Liquidity risk also remains elevated, and in a risk-off environment, small-caps face sharper drawdowns due to lower institutional float. We need to be selective rather than broadly bullish.

Focus on small-caps with strong balance sheets, consistent free cash flow generation, and identifiable earnings catalysts for FY27. Avoid names that rallied purely on momentum without fundamental backing. A 15–20% allocation to quality small-caps in a diversified portfolio is reasonable at current levels — not more.

What is your reading of sectoral rotation at this stage of the cycle, particularly across banking and financials, capital goods, manufacturing, IT services and consumption?

We appear to be in a mid-cycle transition, and rotation is becoming more nuanced:

• Banking & Financials: After underperforming for 12–18 months, it is improving. Valuations are attractive, credit costs are peaking, and rate cuts will support NIMs over FY26–27. Private banks look better positioned than PSUs at this stage.
• Capital Goods & Manufacturing: Still structurally in favour, but valuations remain elevated. Stock-specific rather than broad sector bets make sense. Order inflow data will be the key monitorable.
• IT Services: Early signs of deal momentum recovering, particularly in BFSI verticals. AI integration is shifting from a threat narrative to an opportunity narrative. Largecaps preferred over midcap IT.
• Consumption: Rural is recovering; urban is moderating. FMCG looks fairly valued. Discretionary is more interesting on dips.

Rotation favours financials and IT over capital goods at current relative valuations.

What is your view on precious metals? Does it make sense to keep buying gold? If you have Rs 10 lakh to invest, how would you divide it among gold and silver, equity and debt considering a 4-5 year horizon and medium risk appetite?

Gold’s rally is structurally supported with central bank buying, de-dollarisation trends, geopolitical risk premiums, and real rate uncertainty all remain tailwinds. We are seeing a regime shift in how gold is being valued globally. Silver has additional industrial demand drivers (solar panels, EVs) making it a higher-beta precious metals play.

For Rs 10 lakh over 4–5 years with medium risk appetite:

This balances growth with downside protection. Rebalance equities faster and other asset classes annually.