Investing in Mid-Cap Stocks

Many investors like to focus on the stocks of small, fast-growing companies. Others prefer the stocks of big, established companies that are household names. But even successful investors may overlook a big part of the stock market: mid-cap stocks.

Like Goldilocks’ porridge, mid-caps are the not-too-big, not-too-small stocks that are “just right” for investors who want the combination of growth with lower volatility that the best mid-cap stocks offer. And if your portfolio holds a lot of small caps or large caps (or both), adding some mid-cap stocks can help you diversify.

Here’s a closer look at what mid-cap stocks are, how to choose the best ones, and how to decide if they’re right for you.

What are mid-cap stocks?

Mid-cap stocks are stocks of companies with a medium-size market capitalization (the cap in mid-cap). They’re so named because they fall between small-cap and large-cap stocks.

We say that a stock is a mid-cap stock when the total value of all the company’s shares outstanding -- meaning the shares held by all shareholders, including company insiders -- falls between $2 billion and $10 billion.

Source: The Motley Fool

Mid-cap companies include fast-growing young companies that have outgrown small-cap status as well as mature companies operating in stable, profitable corners of the market.

While small-cap stocks are often fast growing but volatile, and large-cap stocks tend to be slow growing and relatively stable, the best mid-cap stocks tend to fall in between: less volatile than fast-moving small caps, but with more growth potential than mammoth large-cap companies.

Mid-cap stocks might not be top performers over short periods, but their combination of lower volatility and higher growth potential often translates into solid returns for mid-cap stock investors over long periods of time.

Five great mid-cap stocks and funds to consider

Don’t be surprised if you don’t immediately know the name of every mid-cap stock you read about. Some mid-cap stocks are household names, of course, but many aren’t, especially companies that operate in specialized industry niches.

Here are some excellent mid-cap stocks to consider:

• Cabot Microelectronics (NASDAQ:CCMP) is a relatively small company in a market segment dominated by giants: semiconductors, or computer chips. Cabot isn’t a chipmaker itself; rather, like the businesses that sold pickaxes to gold-rush miners, Cabot supplies chipmakers with chemicals and cleaning products used in the semiconductor manufacturing process. The semiconductor industry can be volatile, as chip designs come and go, but overall growth of chip production tends to be relatively steady. Cabot’s results have been steady as well.
• Livongo Health (NASDAQ:LVGO) offers a suite of wirelessly connected products that help people with chronic health conditions such as diabetes monitor and manage them. Livongo’s devices gather data that the patient might not otherwise have and present it in easy-to-understand formats. The company operates with a subscription model, which helps reduce sales volatility, and has been posting strong growth in a huge potential market.
• Peloton Interactive (NASDAQ:PTON) is a great example of a fast-growing young company that has “outgrown” small-cap status. The maker of internet-connected exercise bikes and treadmills has enjoyed strong growth over the last several quarters, thanks to its habit-forming combination of high-quality equipment and fun online classes. Don’t be surprised if this one outgrows mid-cap status in another year or two.

You can also add the benefits of mid-cap stocks to your portfolio by investing in a fund that focuses exclusively on mid-caps.

• Vanguard S&P Mid-Cap 400 ETF (NYSEMKT:IVOO) is an exchange-traded fund that tracks the performance of the S&P Mid-Cap 400 Index, a leading index of mid-cap stocks.
• Fidelity Mid-Cap Stock Fund (NASDAQMUTFUND:FMCSX) is a mutual fund that invests in mid-cap stocks that have high growth potential or are selling at value prices or both. It’s actively managed, meaning that its portfolio manager aims to beat the performance of the S&P Mid-Cap 400 Index, not just match it. Actively managed funds like this one have somewhat higher fees than index ETFs so the fund can pay its (human) managers. But the goal of active management is to deliver improvements in performance that will more than cover the difference.

How to evaluate top mid-cap stocks

Mid-cap stocks are often former small-cap growth stocks, and finding the best of them is a lot like searching for great small-cap stocks. Generally you want companies with visionary leaders, easy-to-see competitive advantages, good brands, and a track record of taking care of investors.

Most importantly, you want to see a history of earnings growth and sales growth over time. If a company is lacking either, you should find out why. Below is guidance for evaluating both of those metrics.

1. Earnings growth: A stock’s price tends to follow the company’s earnings over time: If earnings are growing, the stock price will tend to rise. Of course, fast-growing companies aren’t always profitable, and in those cases you want to see losses shrinking as sales grow. If losses are increasing while sales are rising, it’s important to understand the reasons behind this.
2. Sales growth: With growth stocks, you want to see that sales -- meaning revenue -- have been growing over time. That shows that the company’s business is a good one with the potential to sustain itself over time; when sales are growing faster than at larger companies, that suggests that the company’s business is a very good one. If sales aren’t growing, take this as a warning sign. It’s essential to have a good reason for this before you invest.

Are mid-cap stocks for you?

If you can hold an investment for five years or more, you’re comfortable with occasional big ups and downs in price, and you like to have a balance of higher growth and lower volatility, then mid-cap stocks might have a place in your portfolio.

Do keep in mind that although mid-caps generally offer more stability than small companies, it’s still important to do your homework before you buy.

If you’re not sure you’re prepared to do the research required to evaluate individual mid-cap stocks, or you don’t want to devote the time necessary to do so, you can still get the benefits of mid-cap stock investing by adding a mid-cap ETF or mutual fund to your diversified portfolio.