Mid-Cap Stocks and Funds With Their Effect on the Economy

Four Reasons to Buy Mid-Cap Stocks and Funds

dollar tree is a mid cap stock
••• Dollar Tree store is seen on July 28, 2014 in Miami, Florida. Photo by Joe Raedle/Getty Images

Mid-cap stocks are shares of public companies with market capitalizations between $1 billion and $5 billion. Some analysts even consider companies as large as $10 billion to be mid-cap. The market cap is found by multiplying the company's number of shares of stock times the current stock price. These are somewhat familiar companies that have good growth potential. 

Should you buy mid-cap stocks or mutual funds? If you purchase individual stocks, you must research each firm to decide which are good picks. It requires time and expertise. The trade-off is that you might find something the stock analysts have overlooked.

It's much easier to select mid-cap mutual funds. These funds are led by managers who know the mid-cap business inside and out. You still have to research them, but that reduces your risk. That's because funds provide diversification. They give you the best return for the least risk over time.

You could also decide to go with exchange-traded funds that focus on mid-cap stocks. They have lower fees than mutual funds. On the downside, you will never outperform the market with an ETF. That's because their goal is to track the market.  

Four Reasons to Buy

Every well-diversified portfolio should have some percentage of mid-cap stocks or mutual funds. The amount depends on your specific investment goals and asset allocation. It also depends on the current phase of the business cycle.  Here are four reasons to buy mid-cap stocks.

1. Business Cycle Expansion. Mid-cap companies do well in the expansion phase of the of the business cycle. Growth is stable while interest rates are still low and capital is cheap. As a result, mid-cap managers can get the low-cost loans they need to meet rising demand. They grow either through investment in capital equipment, mergers, or acquisitions. 

2. Mid Cap Versus Small Cap. Mid-cap companies are not as risky as small-cap businesses.  In an economic downturn, they will be less likely to go bankrupt as a small-cap company.

Mid caps have usually been around longer, so you can get more information about them through research. They have more of a track record and are a bit more stable.

In fact, you must research before purchasing mid-cap stocks. These companies have different earnings and growth potential.

For example, some may remain a mid-cap stock indefinitely. Their business model may not allow them to grow any larger. They may be meeting all the demand for their product that exists. In another case, their management may not want to become a large-cap company. They may enjoy running a mid-size firm. 

There are some with solid earnings but are in an unattractive segment of the stock market. As a result, they have a low price-to-earnings ratio. Even though their sales are strong, investors don't like their industry. Without that penalty, these mid-caps could otherwise become large cap.

Other mid-cap companies may be poised to be the next big breakout. They may be on the verge of announcing a new product or acquiring a competitor. In these cases, a mid-cap can provide the same growth potential as a smaller firm with less risk.

Another way a mid cap could pay off is if a large-cap company decides to buy it. In that case, your stock might get converted to the large-cap stock. If the switch is generous, you could gain a lot. 

3. Mid Cap Versus Large Cap. A mid-cap company will not be as stable as a large-cap company. First, they don't have as much capital to last through a downturn. Therefore, they will be riskier in the contraction phase of the business cycle. Second, they are usually focused on one type of business or market. If that market disappears, they will too. 

4. Mid Caps Outperform Both Large and Small Cap. John Roth, the portfolio manager of Fidelity Mid-Cap Stock Fund, found that mid caps have outperformed small and large caps over the last 20 years. He compared the returns of the Russell MidCap® Index with both the Russell 2000® Index (small-cap) and Russell Top 200® Index (the 200 largest cap). Mid-caps outperformed consistently. They have the lower risk than the small caps, but a higher return than the large caps.

Examples 

Many mid-cap companies are well known. They have been around long enough to secure their market niche. Many mid-cap companies are in the finance, real estate, or transportation industries. Here's a list of some well-known mid-cap corporations:

  • 3D Systems Corp
  • Dollar Tree Inc.
  • Nu Skin Enterprises
  • Pitney Bowes

This list is not in any way an indication that these are safe investments. That's the role of a good financial planner. Mid-cap stocks may not even be a good fit for your personal investment goals. Consult with a financial planner to determine how mid caps fit into your asset allocation.