Mid-caps: The Goldilocks asset class?
While the idea of “taking the middle ground” can imply ho-hum mediocrity, investing in mid-cap stocks is anything but. Portfolio manager John Ettinger explains why investing in mid-caps can be a solid component of any portfolio strategy.
Q: How do you define mid-cap?
These stocks are traditionally companies with market capitalizations of $4 billion to $18 billion, although the delineation among small-, mid- and large-caps can vary. For comparison, the average market cap of the 30 stocks that comprise the Dow Jones Industrial Average is nearly $218 billion while that of the Russell 2000 Index, representing small-caps, is about $2.3 billion.
Q: What’s the appeal of investing in mid-caps?
Most investors readily see the diversification benefit of including both small- and established large-cap stocks in portfolios. Often overlooked, mid-caps offer some of the best attributes of each. Consider that mid-sized companies have survived their launch phase. Their managements are that much more experienced and have prevailed through many of the early challenges that small companies confront. As a result, they are generally less risky while still offering long-term growth potential. They also have better access to capital, so their financial resources may be greater.
Compared to their larger counterparts, mid-sized companies often have more attractive valuations and less coverage by Wall Street analysts, presenting an advantage for active managers. Their growth rates also are typically higher and they are more flexible and better able to adjust to changing market conditions. In addition, mid-sized companies are more likely than large companies to be acquisition targets, presenting additional opportunities.
Q: What are important elements when it comes to evaluating mid-caps?
Important factors to consider are the price-earnings ratio and free-cash-flow yield compared to a company’s own history and to its competitors. At Federated Kaufmann, we like companies with strong balance sheets, excellent managements, potential for establishing a wide competitive moat and overall performance that supersedes constantly shifting macro environments. Many of the stocks in our mid-cap portfolio were purchased at their initial public offering or when they were small-caps and subsequently grew to their current size, so we know their quality and potential.
Q: How are mid-cap stocks faring in the current environment amid slowing global growth and trade tensions?
Mid-cap stocks tend to have less international exposure compared to large-caps and an overall lower risk profile relative to small-caps, which makes the asset class particularly attractive in this environment. Because they tend to have more domestic revenue compared to large-caps, mid-caps are supported by a more robust U.S. economy and stronger U.S. dollar. And while not totally insulated from global events, mid-cap companies are more nimble than large companies and have greater flexibility to adjust their supply chains and other operations in response to situations such as the uncertainty surrounding the U.S.-China trade policy.