By Philip van Doorn, MarketWatch
Mid-cap stocks fly under the radar, wedged between fast-growing small-caps and established large-caps.
But their long-term performance as an asset class has been good enough that you should think about diversifying your investment portfolio to include them.
Financial media headlines are rightly fixated on the large-cap companies that drive the stock market. After all, the largest exchange traded fund (ETF) — the SPDR S&P 500 ETF Trust /zigman2/quotes/209901640/composite SPY +0.48% — has $279 billion in assets and there are other giant ETFs and index mutual funds that track the S&P 500 /zigman2/quotes/210599714/realtime SPX +0.47% . So even with the diversification of the large-cap benchmark, you are running with the herd.
Small-cap companies also receive their share of coverage, as they tend to post the fastest profit or sales growth. As a result, mid-cap companies tend to be overlooked, even though as a group they have been excellent in the long term.
Will Muggia, CEO of Westfield Capital Management of Boston, explained how he picks stocks for the Touchstone Mid-Cap Growth Fund /zigman2/quotes/207917304/realtime TEGIX +0.74% and named several examples of successful companies it holds.
Westfield Capital Management manages about $13.5 billion in assets for private and institutional clients. The firm subadvises for the $1.2 billion Touchstone Mid-Cap Growth Fund, the Harbor Small Cap Growth Fund /zigman2/quotes/207722011/realtime HASGX +0.54% and the Westfield Large Gap Growth Fund /zigman2/quotes/200037790/realtime WCLGX +0.51% , among others.
Definitions of stocks’ asset-size classes differ, but the Russell Mid-Cap Index /zigman2/quotes/210598151/delayed RMCC +0.31% included 784 stocks a median market capitalization of $8.1 billion as of March 31.
Check out this 30-year chart showing the performance of the Russell Mid-Cap Index, the small-cap Russell 2000 /zigman2/quotes/210598147/delayed RUT +0.54% and the (mostly) large-cap Russell 1000 /zigman2/quotes/210598144/delayed RUI +0.48% :
Muggia, in an interview, said his team’s stock-selection strategy could be abbreviated to GARP, which stands for “growth at a reasonable price.” The focus on value has helped the fund to outperform the Russell Mid-Cap Index and the Russell Mid-Cap Growth Index /zigman2/quotes/210598134/delayed XX:RMCCG +0.62% (the fund’s benchmark) during down cycles for stocks. That has led to outperformance against those benchmarks over the past three and five years, as you can see below.
Muggia said the fund’s value focus provides protection during periods of market weakness — something easily overlooked in light of the general upward trend for the stock market since the post-crisis bottom in March 2009.
“Often the most expensive companies got hit the most. Our focus is identifying companies with superior franchises with above-average growth prospects, trading at below average multiples to either earnings or cash flow,” he said.
Highlights of holdings, including ‘best-managed company’
Muggia talked about five of the fund’s holdings that he believes are excellent examples of his “growth at a reasonable price” mantra:
Fidelity National Information Systems
Fidelity National Information Systems /zigman2/quotes/207166559/composite FIS +1.05% provides integrated systems for banks and to payment processors and asset managers. Fidelity National and Worldpay announced a merger agreement in March, through which Fidelity National will acquired the merchant payment processor for about $35 billion in cash and stock.
Muggia said Fidelity National has “a very successful track record of integrating acquisitions. Historically they have beaten all of their synergy estimates.” Westfield first held the stock in its small-cap portfolios, before it “graduated” to a mid-cap, he said.
He expects Fidelity National to “grow revenue 7% to 8% organically,” with annual growth of earnings per share of about 15% over the next three to five years.
Muggia said Lululemon Athletica /zigman2/quotes/204011506/composite LULU +1.27% has been showing “the strongest same-store sales growth of any store I have seen.” For fiscal 2018 ended Feb. 3, Lululemon said comparable-store sales rose 7% — an impressive number, considering how difficult it is for most brick-and-mortar retailers to increase sales as consumers find better prices on Amazon.com /zigman2/quotes/210331248/composite AMZN +0.67% and other websites.
During fiscal 2018, Lululemon’s net sales increased 24%, while gross profit rose 30% and earnings per share (EPS) jumped 90%.