A Middle Road Between Blue Chips And Startups

When Standard & Poor's launched a midcap index in June, 1991, it shone a spotlight on stocks of midsize companies. Since then, investment firms have scurried to create new midcap mutual funds such as PFAMCO's Midcap Growth--or to reposition old funds to focus on companies with market capitalizations of $300 million to $5 billion. With all the attention, you might think the best stocks had been taken. But midcaps should remain hot in the 1990s.

One reason is they offer a happy medium between growth and stability. They combine seasoned managers and operations with startup pizzazz. "Once companies survive the small-cap arena, they usually go through a growth spurt," says Jennifer Silver, portfolio manager at Putnam's Vista Fund, which switched from value to midcap stocks two years ago.

After a painful recession, midcaps pulled ahead of their larger brethren in the recovery, partly because of well-defined niches unaffected by the worldwide economic bust. Since 1991, midcaps have chalked up annual returns of 25.7%, close to the small caps' 28.7% but well above the S&P 500's 16%, says Prudential Securities analyst Claudia Mott. Midcaps soared in August and are now falling a bit. Over the past 15 years, however, the sector outperformed small and large caps, according to Marty Ryan, an analyst at consultant Frank Russell Co. He says: "It bats for average--it doesn't hit home runs."

GAINERS. While midcaps are no longer cheap, analysts say they're still fairly valued, with a price-earnings ratio of 22.57, vs. 24.05 for large caps. That's partly because they outnumber large-cap stocks and are less scrutinized. "Only half as many analysts follow midcaps, yet they make up one-third of the total market, vs. only 5% for large-caps," says Putnam's Silver. She points to Perrigo, a $2.3 billion maker of over-the-counter drugs, personal products, and vitamins with projected annual growth of 26% over the next five years. Its products often carry store labels and sell for 60% less than name brands.

When picking midcaps, look for companies that are gaining market share faster than their peers and that have higher return on sales and equity, says Alan Leifer, who manages Fidelity Investments' midcap Trend Fund. He also chooses stocks where management owns at least a 10% stake. Examples: Telephone & Data Systems, a wireless-communications company, and Centex, the nation's No.1 homebuilder.

Or let a fund manager do the picking. It can be hard to tell which funds specialize in midcaps, since many don't have "midcap" in the name. It pays to ask, because only their managers know for sure.

      FUNDS       1993 TOTAL RETURN        THREE-
                  (through Oct. 31)        YEAR
      FIDELITY TREND        19.8%           28.98
      IAI MIDCAP GROWTH     18.92            NA
      PUTNAM VISTA          13.39           26.53
      DREYFUS' PEOPLES      11.09            NA
      S&P 500                9.79           19.08 
      NA=Not applicable        DATA: MORNINGSTAR INC.
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