Indian stocks have been among the best-performing markets globally. This is reflected in the doubling of frontline indices over the last 10 months.

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However, this has also led to large caps becoming expensive in relation to history, valuations and breadth. Small and Midcap stocks have also rallied and not only outperformed benchmarks but continue to see more opportunity as the domestic economy recovers fully from COVID shock.

The Nifty Midcap and Nifty Smallcap indices have risen 12 percent and 13 percent, respectively as compared to a 9 percent rise in benchmark Nifty.

The recent policy decisions for economic revival may be more positive for midcap and smallcap shares over largecap stocks, said brokerage firm Edelweiss said in a recent note.

Edelweiss believes that most froth has built-in large caps, with valuations pointing to depressed returns and consolidation while more steam is left in the broader market — especially mid and small caps.

The brokerage recommends increasing stakes in such companies.

"We believe that a possible consolidation or correction in the next few months should be utilised to add to small and midcap stocks. We estimate that Small and Midcap space is likely to yield a large number of opportunities over the next few years and would continue to be part of the Indian growth story," Edelweiss suggested investors.

Among individual stocks in the midcap index, Adani Enterprises rose the most, up 62 percent in 2021. Meanwhile, stocks like IDFC First Bank, Shriram Transport, Ashok Leyland, Cholamandalam Investment, Dalmia Bharat, Apollo Tyres, TVS Motor, and Cummins India were up between 30 percent and 45 percent.

In the smallcap space, Bajaj Electrical was the top gainer, up 74 percent followed by Tata Elxsi and CEAT which rose 56 percent and 52 percent, respectively. Other smallcap stocks like Indian Bank, Graphite India, Dilip Buildicon, IndiaMart, Affle India, and Trident were up over 40 percent each.

It sees three drivers for small and midcap stocks:

− First is the possibility that higher government expenditure due to a more relaxed glide path will allow the Indian economy to heal faster. Small and mid stocks are more aligned to the domestic economy and the recovery thereof.

− Monetary policy is likely to be supportive in FY22. This is because the global policy signals remain benign, inflation in FY22 remains under control with the union budget appearing noninflationary and the small-sized firms are now slowly beginning to get benefits of a loose monetary policy which has benefited only bigger firms until recently.

− The near 25 percent rally in frontline indices has coincided with record FPI flows into equity markets. As per estimates more than three fourth of all these flows are targeted towards the top 50 large stocks. In comparison, the domestic flows which are more focused on companies outside of the large-cap universe have been set sellers. These funds are likely to remain a buyer of dips in small and midcap space.

Here are its top picks in the mid and smallcap space: