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Hidden gems are often unnoticed, and mid cap stocks are no exception. While large cap stocks dominate the news and drive investors’ sentiment, the real wealth creation happens in the mid cap stocks universe, which most investors miss when they are available at cheap valuations. Mid cap stocks have the potential to deliver stronger returns than the large and small cap stocks universe.
So, in this article, we will discuss- what are mid cap companies, what are mid cap stocks, their features, and the benefits of investing in midcap stocks.
What are Mid Cap Companies?
On the scale of valuation, mid cap companies market capitalization are less than $10 billion.
Like the widely tracked midcap index in the US, S&P Midcap 400 index tracks 400 mid-sized companies with market capitalization ranging from $2 billion to $8 billion.
Apart from the market capitalization, the major difference between the large-cap and mid cap stocks is their market position. Most large cap companies have an established market position with steady financials. While mid cap companies are in the phase of rapid expansion and growth after perfecting their business model.
Because of the higher growth rate, midcap stocks are preferred by investors for long-term wealth creation.
However, investing in mid cap companies also has its share of risks and challenges.
During market downturns, midcap stocks can be more volatile than large-cap stocks. Also, period of slow growth or lower than estimated growth can significantly impact the stock return.
Because of such risks, beginners and risk-averse investors should avoid investing in midcap stocks.
Why Invest in Mid Cap Companies?
The following are the benefits of investing in mid cap companies:
Balanced Growth and Stability
Fundamentally strong mid cap companies offer a unique blend of balanced growth and stability. Such businesses are safer to invest in and have the capability to grow and expand at a rapid scale. Their stocks can perform much better than large-cap stocks over the long run.
Also, those mid cap companies that are showing high growth potential already have proven business models in place. They also have experienced management.
Potential for Outperformance
Historically, midcap stocks have generated higher returns for investors.
Mid cap companies can grow their revenues and profit quickly and at a faster rate than large cap companies. This has a positive impact on the stock price growth. Additionally, mid cap companies are more agile than large cap companies. It allows them to adapt quickly to market changes and capitalize on new growth opportunities.
Less Competition from Institutional Investors
When it comes to attracting large institutional investors, large cap stocks often take the lead. They focus on the stability and liquidity of the stock, which midcap stocks lag sometimes.
For small retail investors, it provides a unique opportunity to invest in such stocks at a lower valuation. Because, once the companies start attracting the attention of large institutional players, valuation skyrockets.
Benefits from Mergers and Acquisitions
Mid cap companies have higher chances of getting acquired by larger companies.
When a large-cap company acquires a mid cap company, it happens at a premium valuation. This can be rewarding for existing shareholders. For example, Microsoft acquired LinkedIn for $26.2 billion in June 2016. Before the acquisition, LinkedIn’s market capitalization was approximately $17.5 billion. Similarly, Marvel Entertainment was acquired by Disney in 2009 at a rich valuation.
Diversification
Investing in good midcap stocks helps to diversify your investment portfolio. Large-cap stocks provide stability and steady returns. Small-cap stocks offer high growth potential but have much higher levels of risk. Good midcap stocks provide a balance of both, creating value in the long term.
Mid Cap Companies: Historical Performance, Challenges, and Market Capitalization
Historical Performance
It has been a general trend in the global market that midcap stocks outperform large-cap stocks over the long term.
As per a study by American Century Investments, midcap stocks have generated greater wealth than large and small-cap peers. The study is based on the returns data of Russell Top 200- Total Return, Russell 2000- Total Return, and Russell Midcap- Total Return over the last 45 years.
How much would you have made in December 1978 if you had invested $10,000 in each of the three indexes? Investing in the Russell Midcap index would have got you $2.4 million, Russell Top 200 index $1.6 million, and Russell 2000 $1.13 million.
As you can see, the mid cap index has given investors a higher long-term return than the others.
Challenges for Mid Cap Companies
Investing in mid cap companies provides high growth potential, but there are risks as well.
First, mid cap stocks are subject to higher volatility than large-cap stocks. During market downturns, they showcase wild price swings and can result in losses in the short term.
Second, mid cap companies often compete with large established players and innovative startups. Sometimes, higher levels of competitive intensity can result in margin pressure for mid cap companies. This can affect earnings growth and can impact stock price growth.
Third, is economic sensitivity. Large-cap companies can withstand challenging market conditions due to their strong financial position. The thing that the mid cap companies lack. A prolonged period of challenging market conditions can lead to the degrowth of companies.
Key Takeaways and Tips
Investing in midcap stocks can be a rewarding strategy, but not all midcap stocks offer promising growth. Following are the factors you should always look at before investing in a mid cap stock.
- Consistent revenue and profit growth for the last five years
- Should have higher profitability and returns metrics. It includes EBITDA, Return on Equity (ROE), and Return on Capital Employed (ROCE)
- The company should have a free cash flow
- Business should be in a sunrise sector with strong growth potential for the next decade
- Strong and experienced management team
By conducting thorough research, you can take advantage of the growth opportunities in good mid cap stocks and enhance overall returns. However, it is important to maintain a diversified portfolio to manage risks. This should include large-cap stocks, mid cap stocks, and low-risk investment instruments.
