Don't Ignore The Middle-Child

By Nancy Zambell, Contributing Editor, Financially Fit

For close to 15 years, I have been a mid cap stock devotee. I have conducted workshops across the country, singing the praises of these oft-forgotten children, while most advisors - and the media - have worn themselves out chasing the volatile up and down movements of small and large cap stocks.

Sure, investors across the board made money, but as a study by the University of Chicago and Prudential demonstrates - when risk and return are taken into consideration - the mid caps have outshone the rest of the market for the last 20 years.

Using The Russell 1000 Index as a proxy for large caps, the Russell Midcap for mid caps and the Russell 2000 for small caps, the returns and risk data are as follows: Returns - 11.9%, 15.0%, and 10.8%; risk - 17.3%, 19.5% and 20.8%, respectively. Consequently, you can see that when risk is taken into account, the returns for mid caps were greater than both large and small, while the risk of investing in mid caps was substantially less than small caps, and just a tad more than large caps.

What that means to investors is this: adding mid cap stocks to your portfolio can not only increase your returns but also reduce your risk.

And so far, year-to-date, according to The Wall Street Journal, the trend is continuing. Stocks in the S&P MidCap 400 have returned 10.2%, compared with 5.3% for the S&P 500 equities and 7.1% for the stocks in the S&P SmallCap 600 index.

So what exactly is a mid cap stock?

First of all, market capitalization is simply the price of one share of stock times the number of shares outstanding. As in all definitions of market capitalization, the classification varies from source to source. But here's how the market cap categories are commonly defined:

• Large cap: More than $5 billion
• Mid cap: $1billion - $5 billion  
• Small cap: Less than $1 billion

Besides their market capitalizations, mid caps also differ in several additional ways from most small and large cap companies.

1. One particular trait that usually makes mid caps less risky than small caps is that most of these companies have generally gone beyond their initial risky startup years and have progressed into a cycle of sustained growth of their sales, earnings and market share.  
2. They tend to be growing less than a small cap but more than a large cap. And since we know earnings drive share prices, they tend to become more valuable over time. 
3. Unlike their large cap cousins, most have not reached the point of getting fat and lazy and continue to pay close attention to not only their top, but bottom lines, squeezing as much revenue as possible right down to their net profits. 
4. Lastly, mid caps are very often ignored by Wall Street. While some are household names like Barnes & Noble, Tractor Supply or Thor Industries, thousands of mid caps are out of the analyst loop. The biggest reason is that many are cash flow rich and have not had to come to Wall Street to issue additional stock for their operating or expansion needs. Yet, the potential for share appreciation is often tremendous. For the investor, that usually means the shares are less volatile, since mid caps tend to have fewer institutional investors. Furthermore, this lack of visibility can turn into significant share appreciation - when the institutions eventually discover the stocks.

There are thousands of mid cap companies that would be suitable for investors. Of course, the same rules as always apply: Search for fundamentally strong companies with growing market shares.

But for investors wanting to dip their toes into the mid cap market without purchasing individual stocks, don't worry. There are plenty of mid cap mutual funds and exchange-traded funds (ETFs) ready for your investment dollars!

Here is a sampling of a few that have recently seen some great performance:

Mutual Funds

ETFs

Source: Morningstar

Good hunting!