Mumbai: Mid and small cap stocks fell sharply on Thursday even as benchmark indices ended on a record high.

The Sensex gained 425 points during the day before closing at 35,260.29, up 178.47 points or 0.51%. The National Stock Exchange’s Nifty index rose 0.26% to 10,817 points.

Banking stocks led the rally on hopes the government may allow 100% foreign direct investment in private banks. Among banking stocks, HDFC Bank (up 2.1%), Kotak Mahindra Bank (up 1.7%), and IndusInd Bank (up 1.3%) were the top gainers.

But the rally in early trading fizzled out during the day. Repeated days of record peaks prompted some investors to book profits as December quarter earnings are yet to show a clear positive trend.

“Increase in FDI limits, if made, will be an incremental positive for private banks, specifically ones with stronger balance sheet and profitability. But given substantial gap even in current FII (foreign institutional investor) shareholding and maximum limit, we expect the impact to be marginal in magnitude," brokerage firm Jefferies India said in a note on Wednesday.

“At a time when majority of the PSU banks are struggling with low credit growth and high asset quality risks, it has been difficult to generate investor interest even at relatively lower valuations than their private peers. We don’t expect higher FDI limits to change things materially, unless the government is able to bring in long-term strategic investors," it said.

Currently, the government allows an aggregate foreign investment in private banks up to 74% of paid-up share capital. The limit is capped at 20% for state-owned banks.

BSE Midcap and BSE Smallcap slipped 1.69% and 2.04%, respectively as investors became concerned about rising valuations.

“There’s a froth building up in a few mid and smallcap stocks, which is leading to profit booking," said Gaurang Shah, head investment strategist at Geojit Financial Services Ltd.

Currently, the BSE Midcap and BSE Smallcap indices are at 23.20 and 19.97 times expected earnings for next 12 months. The Sensex is trading at 18.98 times expected earnings for the next 12 months.

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