David Snowball, PhD, publisher of MutualFundObserver.com, an independent mutual fund–analysis website that tracks 36,000 investment products. He also is professor of communications studies at Augustana College, Rock Island, Illinois.
Bottom Line: The medium-sized companies feature the best attributes of large and small companies
Most stock investors focus on the big or the small. Great big companies feel relatively familiar and powerful. Small companies offer more excitement and adventure.
But what about the middle? Medium-sized companies—those with market capitalizations (total stock market value) between $2 billion and $10 billion—often get ignored. And yet, many of them combine some of the best attributes of large and small companies. And overall, mid-cap stocks have outperformed in the long run. Over the past 20 years, mid-cap stocks have returned an annualized 8.5% versus 5.9% for large-caps and 7.4% for small-caps.
Medium-sized companies tend to have more reliable revenues and seasoned management than small-caps. That makes them less risky and easier to stick with through ups and downs of the economy and the stock market. At the same time, medium-sized companies may have more opportunities to grow their existing businesses than large companies, whose sheer size and bureaucracy often hamper their ability to boost revenues and profits unless they buy up competitors.
This year, mid-cap stocks also have the advantage of being less expensive overall than small-caps. The S&P MidCap 400 Index, based on earnings estimates for the next 12 months, recently traded at 16.8 times earnings compared with 18.3 for the S&P 600 Index of small-caps. The S&P 500 large-cap index was at 16.7, similar to the mid-cap index, but several large technology companies have been trading at much higher price-to-earnings ratios (P/Es), including 87 for Amazon and 133 for Netflix, sparking fears of sharp pullbacks.
The best way to invest in mid-cap stocks is through diversified no-load funds that focus on them. Below are six of my favorites. While most are available to new investors, two have had so much success and popularity that they are closed to new investors but still are accepting additional purchases from existing share owners…
These mid-cap stock funds are most appealing to cautious investors who don’t want a lot of volatility. They tend to invest in undervalued companies that are growing steadily and can hold up well in all types of market environments.
• Carillon Scout Mid Cap (CSMZX). Fund manager Patrick Dunkerley is a former Air Force B-52 bomber crew member who puts every company he invests in through a rigorous checklist that demands a strong balance sheet, reasonable debt load and strong cash flow from operations. Dunkerley’s portfolio of about 130 stocks emphasizes real estate investment trusts (REITs), utilities and industrial companies—high-quality companies that tend to fall behind the broad market in rallies but lose less during downturns. The fund has high portfolio turnover because it is quick to sell holdings that falter. The resulting lack of tax efficiency makes it a better investment for tax-advantaged accounts. Top holdings: EPR Properties, a REIT specializing in entertainment retail centers and recreational parks…and electronic–bar code maker Zebra Technologies. Performance: 17.1%.*
• Parnassus Mid-Cap (PARMX) offers a concentrated portfolio of about 40 stocks, but it has managed to be far less volatile than almost all of its peers. It reduces risk by screening stocks for social responsibility. This strategy doesn’t just screen for negative social factors—which eliminates companies that make liquor, tobacco and weapons. It also looks for positive factors such as support for local communities and healthy workplace environments. These principles often tilt the fund’s portfolio toward technology and industrial stocks. Top holdings: Trimble, which manufactures lasers and optical products for global-positioning systems (GPS)…and data-analytics company Verisk Analytics. Performance: 15.9%.
• T. Rowe Price Mid-Cap Growth (RPMGX) defies gravity. Brian Berghuis has managed the fund, which is closed to new investors, for more than a quarter of a century. He has produced stellar returns despite the fund’s mammoth size, recently holding more than $30 billion in assets. Berghuis uses a blended approach in his 134-stock portfolio, mixing what he calls “plodders”—undervalued companies that grow steadily—with pricey, faster-growing stocks. Top holdings: Metal-can manufacturer Ball Corporation…and Internet media company IAC. Performance: 17.9%.
These funds, which typically invest in companies whose earnings grow 20% or more annually, tend to jump when the market is rising. The trade-off is higher volatility, so the funds are best suited for more adventurous investors.
• Dreyfus/The Boston Company Small/Mid Cap Growth (SDSCX) is among a growing number of “smid-cap” funds that are willing to buy small companies and hang on to them as they grow into medium-sized ones. About 70% of its 95-stock portfolio was recently invested in mid-cap stocks. The fund looks for companies tapping into compelling long-term trends that will keep expanding even through tough economic times. These include the rise in artificial intelligence to help businesses analyze data and make better, more profitable decisions and the increasing need for cybersecurity as hackers continue to disrupt government and business databases. The fund, which keeps about 45% of its assets in technology, likes businesses with dominant positions in their market niches, solid cash flows and strong balance sheets. Top holdings: HubSpot Inc. which provides computer cloud-based marketing and sales software…and the cybersecurity firm Rapid7. Performance: 17.3%.
• William Blair Small-Mid Cap Growth (WSMNX). This smid-cap fund recently had 80% of its assets invested in mid-cap stocks. The fund hunts for companies with a unique product or service…robust cash flow…low debt…and a leading position in a fragmented industry niche. Top holdings: Encompass Health, which owns rehabilitation hospitals…and BWX Technologies, which designs naval nuclear components and reactors for the federal government. Performance: 17.5%.
• Primecap Odyssey Aggressive Growth (POAGX) has one of the strongest performance records of any mid-cap fund, ranking in the top 2% of its category over the past 10 years. But it also has the highest volatility of any of the funds listed here, thanks to its contrarian style. The five managers of the fund, which is closed to new investors, invest in companies with rapidly growing earnings but wait until they are trading at bargain prices due to setbacks. Their picks often are very out-of-favor stocks that the fund will hang on to for years until they turn around. The fund recently had just 50% of its portfolio in mid-caps because it is willing to hold winning stocks even as they grow into large-cap territory. Top holdings: Biotechnology company Nektar Therapeutics…and computer-memory maker Micron Technology. Performance: 21.1%.
*All performance figures are 10-year annualized returns from Morningstar Inc., through March 31, 2019