By Jeff Reeves
This year certainly has thrown its fair share of curveballs. And one unusual factor in the stock market this year has been the rise of “Goldilocks” midcap stocks that are neither too big nor too small to succeed in this fast-changing environment.
Consider that the Russell 2000 index /zigman2/quotes/210598147/delayed RUT -1.49% of midsize U.S. corporations tallied its sixth record close of 2020 right after Thanksgiving, topping off a 15% surge since Election Day. But even more impressive is how this midcap index has diverged from the S&P 500 /zigman2/quotes/210599714/realtime SPX -0.72% over a slightly longer horizon; the Russell 2000 is up about 18% since Sept. 1 while the large-cap S&P is up only about 3%.
So what gives? Well, many large companies simply cannot respond fast enough in a challenging market environment. When you command multinational operations with thousands of employees, change takes time. On the other hand, small-cap companies can be agile but tend to operate with little margin for error. Big and well-capitalized firms may simply see their shares drift lower, but small firms risk going under during a prolonged crisis.
In between those two words lie midcap stocks like those that make up the Russell 2000. Valued at around $2 billion to $10 billion, these “Goldilocks” stocks that are neither too big nor too small. The following five stocks all show in different ways how this middle road of midcaps could be your best bet in this market environment.
Admittedly, cosmetics giant Coty /zigman2/quotes/208645074/composite COTY -3.77% has been giving investors headaches for years. Since setting all-time highs in 2015, the company has seemingly taken one wrong step after another, and shares have plunged about 80% over that time. A short list of reasons include an acquisition spree that prompted rising debt levels and lawsuits over deceiving shareholders , and a ton of turnover at the top with four CEOs in the span of one year.
But that’s hopefully all old news now, and Wall Street seems more interested in Coty’s future than its past. The stock surged 12% in a single session in November on a big upgrade from Citigroup and a $10 price target — roughly 40% higher than current levels. What’s more, those gains come as the stock has skyrocketed 150% since the end of September.
Admittedly, the pandemic means it’s not the best time to be in the cosmetics biz. But the coronavirus-related crash for the stock in early 2020 also came at a time Coty got religion about its turnaround plans, reducing its product portfolio and cutting costs. That didn’t just include the normal route of layoffs but also outsourcing production and optimizing its supply chain as well as slashing executive pay by 25% .
The results have seemingly paid off, with a return to profitability forecast this fiscal year and earnings expected to be about 10 cents per share. That will surge to more 30 cents next fiscal year if forecasts hold.
There is clearly risk in a midcap turnaround story like Coty, but Wall Street also sees some big potential as this stock rides its recent momentum higher.
While things haven’t been particularly rosy for some consumer discretionary names in 2020, footwear giant Deckers Outdoor /zigman2/quotes/203810494/composite DECK +0.66% has shined thanks to its strong brand and direct-to-consumer model. Shares are up more than 50% year-to-date and more than 300% in the last five years, with the strong long-term uptrend disrupted only for two months or so in the spring during the worst of the coronavirus-related market volatility.
With loyal customers eager for its UGG boots and Teva sandal brands, Deckers has been able to command premium prices lately — but more importantly, it is building its own e-commerce engine to cut out third-party retailers and keep more of the profits. This spring, online sales more than doubled as Americans were forced to forgo the mall. And with projected revenue growth of more than 13% next fiscal year, investors can expect profits to get an even bigger shot in the arm as the company’s direct-to-consumer margins are much better than traditional wholesaling.
Wall Street analysts have been gushing over this stock for good reason, with four upgrades to the stock’s price targets in October after Deckers reported record revenue and earnings . And the highest of these targets, $302 from Telsey Advisory Group, implies more than 15% upside from here, even after that already impressive run in 2020.
As the global economy faces less commuting in the short term because of coronavirus and reduced fossil-fuel usage in the long term thanks to global warming, it may surprise you that Diamondback Energy /zigman2/quotes/201200230/composite FANG -4.35% has become so popular.
Sure, earnings are admittedly much lower this year than last year, and shares are roughly a third of where they were in 2018. But the stock has roughly tripled from its 52-week low earlier in the year and now seems to have normalized after implementing production cuts and cost-savings plans. In fact, according to a November call with analysts, FANG’s oilwell costs are down 30% compared with 2019.
And slowly but surely, oil has crept back above $40 a barrel as OPEC continues to talk up production cutbacks . This one-two punch allowed the company to reaffirm its fourth-quarter guidance in October and sparked a roughly 80% rally for shares during November.
Diamondback is not without risks. But investors should take heart that the company posted just over $1.7 billion in operating cash flow across the first nine months of 2020, very close to the $1.8 billion in 2019, and remains soundly profitable.