MW These 11 midcaps are popular right now among investment newsletters but not because of their market valuations
Mark Hulbert
Bigger than small caps. Smaller than large caps. Are they, as in the fairytale, 'just right'?
Most of Wall Street's midcap narratives boil down to asserting that such stocks are neither too big nor too little but "just right."
Are midcap stocks a distinct asset class in their own right?
I'm referring to stocks that are larger than small-cap stocks but smaller than the large caps. To the extent such stocks constitute a separate asset class, some of their returns will be a function of being a member of that class. If so then, in addition to analyzing a stock's fundamentals when deciding whether to invest in it, you should also focus on whether it is in the midcap category.
Wall Street long ago decided that the midcaps are a separate asset class. Fund and ETF screener FundXLS puts 165 ETFs and nearly 600 open-end mutual funds in its midcap category.
Yet I can find no plausible rationale for why midcap stocks should be considered a distinct asset class. Most of Wall Street's midcap narratives boil down to nothing more than asserting that such stocks are neither too big nor too little but "just right." But these narratives tell you nothing more than that Wall Street's brokers were exposed at impressionable ages to the Goldilocks fairy tale.
A more helpful perspective comes from assuming for the moment that midcaps are a distinct asset class, and then comparing their returns with those of small- and large-cap stocks. Take a look at the accompanying chart, which is based on the trailing five-year relative strength of midcap stocks, defined as the 40% of stocks in the middle of the market-cap distribution of U.S. stocks. One of the chart's lines plots midcaps' returns relative to the small caps (the bottom 30% of the distribution) and the other relative to large-cap stocks (the top 30%). Notice first that there is no consistency in midcap relative strength. So, even if you were inclined to treat midcaps as a distinct asset class, you'd still need to know whether they are about to outperform or underperform the smallest or largest stocks
Notice also that midcap relative strength compared with the large caps is often the mirror image of midcap relative strength compared with the small caps. That means that when midcaps are outperforming the large caps, they are underperforming the small caps - and vice versa. In other words, the midcaps' average returns are almost always in between those of the largest and smallest stocks.
Aiming for middle-of-the-road returns could still be a compelling strategy if the midcaps produced superior risk-adjusted performance. But they don't, according to data from Dartmouth professor Ken French. Since the mid-1920s, the average large cap sports the best return-to-risk ratio of the three size categories.
Picking the best midcap stocks
The investment implication: When considering a stock that falls within the size range associated with the midcap category - commonly assumed to extend from $7 and $20 billion - you should base your decision on its fundamental and technical characteristics rather than its size.
With this thought in mind, I constructed the table below of stocks that currently are recommended for purchase by at least two of the investment newsletters monitored by my performance-auditing firm, and whose market caps fall within the midcap range.
Note that, in each case, the newsletters recommending the stock are doing so for reasons having nothing to do with where it stands in the market-cap ranking.
Ticker symbol Company name Market cap (in billions of dollars) GIS General Mills 19.7 GEN Gen Digital 17.5 UNM Unum Group 14.3 HRL Hormel Foods 13.8 DECK Deckers Outdoor 13.3 BF.B Brown-Forman 13.2 WTRG Essential Utilities 11.4 COLB Columbia Banking Systems 8.8 KNSL Kinsale Capital Group 8.5 TAP Molson Coors Beverage 8.0 AGCO AGCO 7.2
-Mark Hulbert