investing

Buy Mid Caps on the Cheap

In spite of a rocky 12 months, mid-cap stocks are in a market sweet spot. And investors should consider snapping them up.

Good news for fans of the Kiplinger ETF 20: Following the latest salvos in the brokerage price wars, customers at practically every major online broker can now purchase all 20 of the exchange-traded funds on our list commission-free. Still, investors are unlikely to look back fondly on free trades if the funds they buy post lackluster results.

Take iShares Core S&P Mid-Cap (symbol, IJH), which after an up-and-down 12 months for stocks is among the worst performers on our list. Its –2.6% return lags the large-company Standard & Poor's 500-stock index by 6.9 percentage points over that period. In one sense, that's to be expected. Stocks with midsize market capitalizations (share price times shares outstanding), typically between $2 billion to $10 billion, tend to fare worse than larger names during market downturns, says BlackRock ETF strategist Elizabeth Grenfell. "Large caps by their nature tend to hold up better during periods of volatility, thanks to their size and the stability of their cash flows," she says.

Baked into the one-year results is a particularly nasty downturn from mid September through late December 2018, when the S&P Mid-Cap 400 index, the benchmark that iShares Core S&P Mid-Cap tracks, fell into bear-market territory with a loss of 21%. Mid caps have been slower than their large-company counterparts to recover, and they still haven't made it all the way out of the hole.

But the lag in mid caps presents investors with the chance to buy good stocks relatively cheaply, says Brian Andrew, chief investment officer for wealth management firm Johnson Financial Group. He says mid caps are in a market sweet spot, capturing the fast growth potential of ascending small firms combined with the financial maturity of larger companies. The potential for mid caps to excel has been borne out historically: From 1994 through May 2019, the annualized return of the S&P Mid-Cap 400 has bested comparable small-cap indexes by 0.9 percentage point and large-cap indexes by 2.0 points. Stocks in the mid-cap index currently trade at 16.7 times projected earnings over the next 12 months, compared with a multiple of 17.2 for the S&P 500.

The best way to invest. Andrew re­commends that investors use the breakdown of the broad market's capitalization as a guide for their domestic stock allocation, with roughly 70% of assets in large caps, 20% in mid caps and 10% in small caps. The iShares ETF is among the most inexpensive and highly diversified mid-cap funds, charging just 0.07% of assets for ex­posure to some 400 stocks.

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