Indian small & midcap stocks have witnessed a sharp rally since the lows of Aug 2013 and have outperformed large caps significantly over this period. A large part of this relative outperformance is explained by the price multiple rerating seen over this period. While the price multiple rerating does explain a large part of equity returns in the short run, it is the underlying business performance and earnings growth that should drive performance in the long run.
In fact it’s quite interesting to note that for small stocks, the multiple re-rating explains most of the increase in stock prices. In other words, the market has rewarded the smallest stocks (through increase in market cap) in spite of reduction in earnings over the last six year period.
To identify stocks that haven’t shown deterioration in financials but have hardly re-rated, we pick the stocks which are common to following categories – top 50% OF stocks on RoCE and top 50% on RoE change and bottom 50% on P/B ratio change. Chart below highlights five stocks from that list that have healthy RoCE and RoE but haven’t been rewarded by the market unlike their peers. 
To identify stocks that have shown deterioration in fundamentals but have over-rated significantly, we pick the stocks which are common on the basis of being in the bottom 50% stocks on RoCE and RoE change and top 50% on P/B ratio change. Chart below highlights five stocks from that list that have poor RoCE and RoE but have been rewarded significantly by the market.
Invest Cautiously as in India we never know which stocks the Fund Managers Reward or the Stock Brokers involve into price rigging. Practice Value Investing based on Fundamentals.