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Over the past year, the key benchmark indices Nifty 50, Nifty Midcap 100 and Nifty Smallcap 100 have delivered returns of 22 per cent, 56 per cent and 66 per cent, respectively.

HDFC Securities said in a report that all three above-mentioned indices seem overvalued at the aggregate level advocating bottom-up stock picking for future returns from here as further expansion of multiples is unlikely.

The report said the extent of overvaluation relative to history is the highest in smallcaps while on an absolute basis, the midcap index is the most overvalued.

Another aspect of this rally is that it’s been very broad-based, which is evident in the fact that 70 per cent of stocks in each of the indices are trading above their long-term (12 years) average valuations.

This level of overvaluation and breadth has been seen only a few times in the past 20 years (in 2007 when 75 per cent of Nifty constituents were overvalued relative to history) and to a lesser extent in FY15-17 (44 per cent of midcap constituents overvalued) and FY21-22 (46 per cent of midcap constituents overvalued), the report said.

In FY07, the overvaluation was corrected through a sharp fall in 2008 across indices. Interestingly, in the last decade, this level of overvaluation in mid and smallcap indices has not always resulted in a sharp index correction in subsequent 1-2 years, but it surely leads to a subdued/modest return in the next few years and the rally tends to get less broad-based, the report said.

“Thus, we believe it’s time for investors to get more selective and bottom-up across all market-cap indices as the phase of easy and broad-based returns might not repeat in FY25-26," the report said.