In the eternal battle between big-cap and small-cap stocks, which group is going to outperform this year? Will the large-cap
index top the charts, as it has every year for the past five? Or will small-company stocks, as represented in the
index, repeat their market-beating performances of 1991, 1992 and 1993?
So far this year, the winner is neither.
As of the close on Sept. 25, the S&P 500 was down 2% since Jan. 3, and the Russell 2000 was up just 4%.
But there is a winner out there: The
S&P MidCap 400
index was up a comparatively stunning 19% year to date as of early this week. Relatively speaking, that often-neglected group of not-too-big and not-so-small equities has been scorching the market this year.
Moreover, I think there's a good chance that mid-caps will continue to leave the rest of the market in the dust during the remainder of this year. Compared with big-caps, the sector offers a combination of solid growth at a reasonable price, plus some shelter from current market uncertainties, such as a meltdown in the euro or a slowdown in Asian economic growth due to high oil prices. And the sector's greater liquidity gives it an edge over the small-cap group for investors who are worried about being able to get out if a stock -- or the market in general -- goes bad.
In a market that has swung between extremes this year -- and that doesn't show any signs of reduced volatility in the weeks ahead -- the middle-of-the-road mid-caps may be just what an investor ordered.
Behind Mid-Caps' Outperformance
Pinning down why the MidCap 400 has outperformed this year isn't an exact science. Some of the credit goes to the index's makeup, which is heavily weighted toward financials such as
Greater Bay Bancorp
, up 61% so far this year, and energy stocks such as
, up 90%. And I certainly wouldn't discount the boost the index got from being underweighted in momentum technology stocks. Most of momentum stocks worth their salt quickly outgrow the mid-cap index, where a market capitalization over $17 billion disqualifies a company as too large, and where the average member is valued at just $2.4 billion. By the time most momentum stocks were ready to take a dive last March, they had joined the big boys and the damage would get marked against the big-cap group.
But I think the mid-caps also offer investors what they are looking for in the second half of the year: solid earnings growth at a reasonable price, and with less risk. For example, I think at the beginning of the year the mid-caps were undervalued relative to large-company stocks. The current price-to-earnings ratio on 12-month trailing earnings for the two indices is now virtually the same -- 28.85 for the MidCap 400, and 28.99 for the big-cap 500.
And there's no doubt that recent earnings jitters due to the impact of a weak euro have had less impact on the average mid-cap stock than on big caps such as
. The average mid-cap company gets more of its sales from the domestic U.S. market and less from Europe and other overseas markets than the average large-cap company.
I've put together a
spreadsheet that lists the 400 stocks in the S&P MidCap index (Netscape users: save this file to your hard drive, then open it), their ticker symbols, year-to-date gains and a few fundamentals about each equity. You can use this tool to go hunting for stocks that seem especially interesting to you.
Three Watch Lists
But I'll also give you a few names that strike me as especially interesting off this list -- ones that, at first glance, seem like they might be worth buying. I'll actually give you three separate lists like that.
First, there are the mid-cap names that I already own in Jubak's Picks. That list includes:
, Global Marine,
Wind River Systems
Second, there are the mid-cap names that might sound familiar from reading my column or other articles on
. This group includes:
Integrated Device Technology
Oxford Health Plans
And then, third, there's a list of five stocks that weren't on my radar until I scanned this list. Call them my personal favorite candidates for further research.
- Kinder Morgan (KMI) - Get Report: Natural gas. Kinder Morgan pipes it, stores it and increasingly burns it. The company has started to build gas-fired power plants along the routes of its 30,000 miles of pipeline. Mutual-fund giant
Fidelity has been accumulating the stock. On Sept. 13, Fidelity International filed a 13G with the
Securities and Exchange Commission revealing that it owned 9.8% of the company. Other Fidelity entities own positions as well.
North Fork Bancorporation (NFB) : If North Fork succeeds in gobbling up another little fish like
Dime Bancorp (DME) it's likely to be just about big enough to attract a bigger fish itself -- one interested in the more than 150 branches the bank has acquired in the New York metropolitan area. The stock formed a solid base at $16 to $17 in the first seven months of the year before making an August move that took it above $20.
Relative strength has increased to 92 in the last three months, from 77 over the last six months. The most recent analyst recommendation I've been able to find put a $25 target price on the stock.
Polycom (PLCM) : Polycom is branching out from its audio and video conferencing business. Its new NetEngine line is designed to let small- to mid-sized businesses or large corporate branch offices to use DSL, or digital subscriber line, technology to integrate broadband voice and data services. The company manufactures private label versions of NetEngine for
Covad Communications (COVD) ,
Lucent Technologies (LU) and
Cisco Systems (CSCO) - Get Report.
Reynolds & Reynolds (REY) : Reynolds & Reynolds owns 37% of the market for providing software and information systems to North American auto dealers. The company is growing market share in that business by about 1% to 2% a year. But the real opportunity lies in Reynolds and Reynolds' ability to build on its knowledge and relationships in that business to add Internet-based software and services for customer-relationship management, or CRM, of parts inventory and procurement and dealer training. The new businesses, which now account for just 20% of projected 2000 revenue, have the potential to grow by 40% or more a year. And thanks to the company's solidly profitable existing business and the sale of some noncore assets, Reynolds & Reynolds has plenty of cash to invest in the new effort.
Williams-Sonoma (WSM) - Get Report: It looks like Williams-Sonoma is getting itself straightened out just in time for holiday shoppers. The company has sold its
Gardeners Eden business, closed some underperforming Williams-Sonoma stores, and turned up the heat in its direct mail and Internet businesses. Operating profit climbed to almost 38% in the second quarter as the company improved inventory systems and buying. For the first time in three quarters, inventory grew at a slower rate than sales in the April-June period.
W.R. Hambrecht has a $48 target price for the stock;
Merrill Lynch has a target of $50.
That's it -- the five mid-caps in the S&P MidCap 400 that interest me the most. Notice something intriguing about this group? No fiber optics companies trading at 400 times earnings and no companies without track records or a history of earnings. Quite a refreshing change of pace.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: America Online, Atmel, E*Trade, Global Crossing, Global Marine, Intel, Nortel Networks and Wind River Systems. He welcomes your feedback at
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