By Philip van Doorn
At this stage of the bull market, there’s been a crowding of money in large-cap stocks, especially growth stocks.
Diversifying into smaller companies might cut risks and put you in a part of the market filled with ripe opportunities at the right time. You can do this with midcap stocks.
Below are three midcap stocks selected by Amy Zhang, who manages the $903 million Alger Mid-Cap Focus Fund /zigman2/quotes/212840468/realtime AFOIX -2.19% and the $7.7 billion Alger Small-Cap Focus Fund /zigman2/quotes/204084512/realtime AOFIX -2.23% . The small-cap fund has a four-star rating (out of five) from Morningstar, and it’s closed to new investors. The midcap fund has no Morningstar rating because it was established on June 14, 2019. It is still open, and its performance has ranked within the top 5% of the roughly 600 funds in Morningstar’s Mid-Cap Growth category in 2021 and 2020.
Here’s a comparison of total returns for the Alger Mid-Cap Focus Fund’s Class I shares and the Russell Mid-Cap Growth Index /zigman2/quotes/210598134/delayed XX:RMCCG -1.74% , its benchmark, since the fund’s inception. As you can see, the mutual fund almost doubled the return of its benchmark.
The Alger Mid-Cap Focus Fund generally holds about 50 stocks. Zhang also manages the Alger Mid-Cap 40 ETF /zigman2/quotes/225084209/composite FRTY -2.70% , which was established in February and follows a similar strategy, but typically holds 40 stocks.
During an interview, Zhang called midcaps “the best of both worlds,” because there are good values to be found off the beaten path, and because there are also growth plays.
In the small-cap focus fund, Zhang’s selections tend to be healthcare or technical companies because those sectors feature so much innovation. But small caps also require heavy research — many companies are expected to be unprofitable for years. Risks are high if a company is only offering one product or service.
When selecting midcap stocks, Zhang follows the same strategy of investing in “positive dynamic change” as she does for small caps. But, she said, for the midcaps “we have the growth case and others participating in the [economic] recovery.”
Midcaps tend to have higher financial quality and more diversified revenue streams than small caps. Therefore, Zhang might pick a stock in any industry, she explained. She also said the Alger Mid-Cap Focus Fund isn’t locked into any sector allocation, as the firm’s strategy “is really about stock selection.”
At the end of September, the fund was “overweight in financials and industrials,” compared to its benchmark index, she said.
“In times like this year, when the market is so macro-driven, while we are still focused on high-quality growth companies in midcap, we [have had] more exposure to cyclicals,” she said, adding that the economic environment has led to better performance for midcaps in 2021 than it has for small caps.
Three midcap stocks
Zhang highlighted three of the Alger Mid-Cap Focus Fund’s largest holdings. Here they are, with consensus revenue estimates for calendar years through 2023, along with expected two-year compound annual growth rates (CAGR) for revenue (in millions of dollars) and forward price-to-earnings (P/E) ratios:
|Company||Estimated revenue – 2021||Estimated revenue – 2022||Estimated revenue – 2023||Estimated revenue CAGR||Forward P/E|
|Upstart Holdings Inc. /zigman2/quotes/223096209/composite UPST||$756||$1,079||$1,376||34.9%||320.7|
|Signature Bank /zigman2/quotes/204403715/composite SBNY||$1,969||$2,349||$2,804||19.3%||19.3|
|Herc Holdings Inc. /zigman2/quotes/209084505/composite HRI||$2,087||$2,447||$2,831||16.5%||21.1|
These are high expected CAGR for revenue. In comparison, the aggregate two-year CAGR for sales are expected to be only 2.5% for the S&P S&P Small-Cap 600 /zigman2/quotes/210599868/delayed SML -3.72% Index and 5.5% for the S&P 400 Mid-Cap Index /zigman2/quotes/219506813/composite MID -1.70% through 2023. The forward P/E ratios for the indexes are below.
Upstart Holdings Inc. /zigman2/quotes/223096209/composite UPST +0.87% has developed a cloud-based lending platform for banks that makes use of artificial intelligence. The service began with a streamlined platform for unsecured consumer loans, including application, underwriting and servicing. The company added a similar service for auto loans during 2020. The service is cloud-based; the company said that during 2020, over half of customers who obtained loans through Upstart had applied using their mobile phones.
“Over time, we really think they will be the one-stop shop, potentially entering cards, mortgages, point-of-sale loans,” and home equity loans, Zhang said. She likes the setup — a company with a small market share in the giant U.S. credit market.