By Lori Ioannou

Midcap dividend stocks, which have been out of favor in recent years, are back on the buy lists of many investment strategists.

These are U.S. companies with market capitalizations between $2 billion and $10 billion that return cash to investors via periodic -- typically quarterly -- payouts.

Why are they back in vogue, after years of lagging behind their larger brethren? For one thing, the midcap dividend stocks provide investors with income to offset share-price declines; the companies also tend to have strong free cash flows to weather economic downturns. In addition, they tend to derive a greater portion of revenue from the domestic market than large-cap companies so they may be better positioned amid disruptions in global trade.

The S&P MidCap 400 Dividend Aristocrats index, a group of 53 midcap stocks that have seen increased dividends for 15 consecutive years or more, is down 1.74% this year through April 30, compared with a decline of 4.92% for the S&P 500 and 9.48% for the Nasdaq composite. The companies in this midcap index derive 82% of their revenues from within the U.S., compared with about 60% for the S&P 500 and 53% for the Nasdaq composite, according to S&P Dow Jones Indices and FactSet data as of April 30.

"These stocks offer some downside protection during this period of market volatility," says Simeon Hyman, global investment strategist for ProShares, adding that this is especially true for investors whose portfolios have become overly concentrated in megacap growth stocks such as the "Magnificent Seven" tech titans. "In this environment it is important to spread your equity exposure broadly to more asset classes to reduce risk."

Key metrics

So what should investors look for when hunting for midcap dividend stocks?

Financial advisers recommend that investors first look at a stock's dividend yield, which is calculated by dividing the annual dividend per share by the share price. The yield measures how much income investors receive for each dollar invested in the stock.

Still, a high yield can be a red flag, particularly when it is the result of a falling stock price. In such cases, investors should be aware of the possibility of dividend cuts -- which often come during times of economic distress.

So advisers say it is important to dig deeper and look at a stock's underlying fundamentals to determine the financial health of the company. "Make sure the company has a strong balance sheet and its prospects for earnings-per-share growth are strong, so the company is well-positioned to maintain dividend payments in the future even if there is a recession," says Jason Alonzo, managing director at Harbor Capital Advisors.

To that end, he recommends looking at the dividend payout ratio -- the percentage of a company's net income that is paid to shareholders through dividends. A range of 25% to 50% is generally viewed by financial pros as healthy, indicating the company has money left over to reinvest for growth.

Other metrics investment pros use to evaluate these stocks are: free cash flow, which is money available to investors after a company has paid for its operating expenses and capital expenditures; free cash flow payout ratio, or the percentage of free cash flow paid to investors in the form of dividends (with a lower ratio suggesting the company generates enough cash flow to cover continued dividends); and the interest coverage ratio, which indicates the company's ability to pay interest expenses due on its debt outstanding from operating income or earnings, with a higher ratio more favorable. That's important since investors want to be sure a company has the financial wherewithal to manage debt and pay dividends.

The most telling metric now may be price-to-earnings ratio, a common measure used to judge whether a stock is overvalued or undervalued. While the P/E ratio of the S&P 500 and Nasdaq composite are about 28 and 32.6, respectively, the P/E ratio of the S&P MidCap 400 Dividend Aristocrat Index is 17.87 as of April 30.

"Now is the time for bargain-hunting since midcap dividend stocks are trading at historically low valuations relative to large-cap stocks," says Larry Adam, chief investment officer at Raymond James. "They could be the sweet spot for investors when you consider they are more insulated from tariff exposure and are expected to outpace the earnings growth of large-caps this year."

What to buy

While you can buy individual midcap dividend stocks, another option is to invest through exchange-traded funds. These funds are tax-efficient and provide diversification across a basket of stocks in different industries. Many have low expense ratios.

The $3.47 billion WisdomTree U.S. MidCap Dividend ETF $(DON)$ has a total return of negative 6.47% for the year through April 30, a 12-month return of 4.72% and a 12-month yield of 2.54%. Its expense ratio is 0.38%. ProShares S&P MidCap 400 Dividend Aristocrats ETF $(REGL)$ is a $1.69 billion fund that has a total return of negative 1.88% year to date and one-year return of 6.96%, and a 12-month yield of 2.60%. It has an expense ratio of 0.40%, Morningstar Direct reports.

While these funds are both down for the year, their dividends help mitigate the overall impact. Also, financial advisers suggest reinvesting dividends rather than taking the cash unless an investor needs it -- a strategy that could pay off in the long term by adding shares at depressed prices.

"By reinvesting dividends within these midcaps, investors could benefit from both price appreciation and the power of compounding," says Gabriel Shahin, president and chief executive of Falcon Wealth Planning. "That combination can offer excellent long-term diversification and a solid growth trajectory."

But high-quality midcap dividend stocks should be just 10% to 15% of a portfolio, financial advisers say. They are long-term value investments with a two- to five-year time horizon or longer, they say. How much an investor allocates depends on risk tolerance, age, income and financial goals.

Lori Ioannou is a writer in New York. She can be reached at reports@wsj.com.

(END) Dow Jones Newswires

May 04, 2025 10:00 ET (14:00 GMT)

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