Mid-Caps Are Shouting: Hey, Look at Us!

This often-overlooked group ran the table in 2000. This year figures to be strong too, if the slowdown doesn't get much worse

Conventional wisdom holds that the middle child gets taken for granted while the littlest and biggest siblings get all the attention. That has certainly been the case in the stock market, where investors tend to dote on large-cap issues and nurture small-caps, often overlooking the mid-caps.

But that may be changing, thanks to mid-caps' superior performance last year. The Russell 2000 index, a key small-cap stocks gauge, sank 3% in value, while its big brother, the Russell 1000 index, slid 7.8%. Meanwhile, the Russell Mid-Cap index, home to some 767 companies in the $3.1 billion-to-$13 billion capitalization range, trotted out a natty 8.3% return. "Earlier in [2000], when growth was still hot, the stocks that were really roaring were the mid-cap growth stocks," says Brad Lawson, senior research analyst with the Frank Russell Co., which owns the Russell indexes. "Later in the year, when value did so well, it was mid-cap value stocks that led it."

The outlook for mid-cap stocks in 2001, particularly value stocks, remains strong, market watchers say. Valuations are still at multi-decade lows compared to large-caps, says Mary Dugan, portfolio manager of the Deutsche Mid-Cap fund BTEAX (BTEAX ). The average price-earnings ratio for mid-caps in 2000 was 24.1, according to the Russell Co., while the average p-e for the top 200 large-caps was 27.8.


  Earnings growth among companies in the midsize asset class is also expected to be healthy, with profits seen rising in 2001 by 21.3%, according to earnings tracking service I/B/E/S International Inc. Of course, the wild card as far as corporate earnings go is the U.S. economy, which Federal Reserve Chairman Alan Greenspan says is essentially stalled.

Despite worries about economic outlook, fund managers like Dugan are optimistic about the class. Mid-caps are "an emerging area that has been overlooked," she says. "We have some companies that are brand names and that are maturing, but that haven't made it to the large-caps yet. They've hit a sweet spot, but there's still growth ahead of them. Dugan's fund, with $372 million in assets, ended last year just slightly south of breakeven, while many growth mutual funds swooned. Dugan says she managed to avoid the bigger losses by easing up on technology, and she credits energy holdings, which benefited from soaring wholesale prices, and shares of hospital companies for keeping her fund from straying too far below the zero mark.

Lawson says it's worth taking a good look at mid-caps but adds that diversification should remain a key investing goal. "We're not big believers in the view that a part of the market will outperform for the long term," he says. "Before 2000, mid-caps had some relatively lousy returns for a few years. This is a lesson in the benefits of being exposed all over the market." He points out that in the mid- to late-1990's, mid-caps lagged behind the large-caps as the nation's biggest companies aggressively cut costs and extended their global reach. In the six years leading up to 2000, profit growth among large-caps exceeded that of mid-caps in four of them.


  Fund managers generally agree that in 2001, value stocks are generally expected to do better than growth stocks, which may be in for a bumpy ride in all classes as Wall Street continues to question valuations of some of the pricier shares amid a cooling economy.

Last year's best performing mid-cap stocks hailed from a variety of sectors, ranging from cigarette maker R.J. Reynolds Tobacco (RJR ) to managed-health-care company Trigon Healthcare (TGH ). The mid-cap growth company with the top return -- a hefty 415% -- was Newport Corp. (NEWP ), which makes fiber-optic and semiconductor testing and measuring systems. On the value side, fund manager Neuberger Berman (NEU ) was No. 1, with a 229% return. Overall, Newport was the top-performing mid-cap, and Neuberger Berman was No. 4.

Among mid-cap funds, one of last year's standouts was the Lord Abbett Mid-Cap Value fund (LAVLX) , which had returns of more than 53%, according to mutual-fund tracker Lipper. Standard & Poor's, owned by BusinessWeek parent The McGraw-Hill Companies, gave the Lord Abbett fund a four-star ranking, its second-highest. (Funds with the highest ranking exhibit the best combination of risk and return compared with their peers over a three-year period.)


  Edward von der Linde, a portfolio manager with the Lord Abbett fund, says some of the sectors he focused on were insurance, financial services, and health care. Many of the holdings were in larger companies in the throes of turnaround -- ones with excellent track records that, for various reasons, had stumbled. "The opportunities [in mid-caps] are just as outstanding as they were in 2000," says von der Linde, who is based in New Jersey. "We continue to believe there is going to be a market of stocks as opposed to a stock market."

Another mid-cap fund boasting big returns last year was the Mercury HW Mid-Cap Value Fund (MMVIX ). Mercury Funds is a component of Merrill Lynch Investment Managers. On a total-return basis, this value fund gained 44.25%, placing it in the top 10 among the 560 funds Lipper tracked in the mid-cap category last year.

Portfolio manager Stan Majcher says his fund surged thanks to a hunch the oil-tanker industry would rebound in 2000. As he tells it, in 1999, there was an oversupply of ships used to transport crude oil. But Majcher says the company predicted that OPEC would boost output in 2000, which would increase the demand for tankers. Turns out the bet was right on, and the sector proved to be the fund's biggest last year. "It fit into our strategy of looking for companies that lack coverage [by sell-side analysts], that have low multiples, and that have earnings that are temporarily depressed," sahs Majcher, who is based in Los Angeles.


  Majcher says positive analyst coverage of a company, which can lure new investment into an issue, tends to drive the stock price. Lack of analyst attention, he says, often means one of two things: either the stock is too trivial to merit scrutiny, or conversely, it's a prime opportunity that has merely been overlooked. And companies with temporarily depressed earnings, Majcher says, have the potential to make nice profits down the road if their earnings were held back by such circumstances as weather.

Although Majcher's focus this year has shifted to utilities and consumer staples, he believes mid-caps will continue to perform well. "You still are getting much better multiples in mid-caps," he says. "However, we believe the economy is easing. We still think that sectors that are defensive are relatively expensive."

He brings up a good point. Although it may be worth broadening a portfolio with mid-caps, they're certainly no more immune to a slowing economy than any other class of stocks. Like their smaller and bigger brothers and sisters, mid-caps stocks are also likely to get slapped if a mother of a slowdown sets in.

By Eric Wahlgren in New York

Edited by Beth Belton

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