Mid-Caps: The Market's Overlooked Sweet Spot

Forbes

4 days ago

Large capitalization stocks are all the rage nowadays. And small-caps often have their day, too. But these two unjustly overshadow mid-caps, which can do very well. Tyra Pratt, portfolio manager at Jensen Investment Management in Lake Oswego, Ore., outlines this opportunity, which too many investors miss:
Larry Light: A lot of people view mid-cap stocks standing in a waiting room, poised to either rise to large-caps or descend to small-caps. And thus they are not that important. Is this perception fair and accurate?
Tyra Pratt: That view is increasingly outdated. While mid-caps were once seen as transitional, on their way to becoming large-caps or falling back to small, they've matured into a distinct and important part of the market. Many are now clear leaders in their industries, with established operations and solid financials, yet they still get treated as if they're stuck in between.
Light: So, what makes mid-cap stocks unique compared to small- and large-caps today?
Pratt: They really offer a balance. Unlike small-caps, mid-sized companies tend to have more stable earnings and experienced management teams. At the same time, they're not so large that they lose flexibility. That agility can be a huge advantage, especially when markets are shifting or when companies need to adapt quickly to new opportunities or risks.
Light: Are there any recent numbers that show how mid-caps have been performing?
Pratt: Absolutely. In the last quarter of 2024, mid-caps posted year-over-year earnings growth of 5%, compared to just 14% for large-caps. That kind of outperformance doesn't often make headlines, but it speaks to the strength and momentum happening in the mid-cap space right now.
Light: How should investors think about size when defining mid-caps? Has that changed?
Pratt: It has. Historically, mid-caps were companies with market values between $2 billion and $10 billion. But the benchmarks have shifted. The Russell Midcap Index now stretches up to $34 billion, and many strategies, including ours, average well above $20 billion. So, if you're still working from decade-old definitions, you might be missing companies that look, act, and perform like large-caps but still sit in that mid-cap bucket.
Light: Some investors worry mid-caps are more vulnerable to market volatility. Is that concern justified?
Pratt: It depends on the company. Mid-caps that are grounded in U.S. consumer or business demand can be surprisingly resilient, sometimes more so than their global peers. They often have less exposure to geopolitical risks like tariffs or international supply chain disruptions. That domestic orientation can help insulate them during periods of global uncertainty.
Light: You've emphasized the importance of quality. What exactly does "quality" mean in the mid-cap space?
Pratt: We consider quality companies to be those with strong free cash flow, low leverage, durable competitive advantages and experienced leadership. Over the past decade, high-quality mid-cap companies, A- or better per Standard & Poor's, have meaningfully outperformed lower-rated peers across short-, medium- and long-term horizons. So quality isn't just a buzzword. It's a major performance driver.
Light: Can you share examples of companies that reflect that mid-cap quality and adaptability?
Pratt: Sure. Encompass Health has established a dominant position in a focused corner of the healthcare market, as the largest U.S. provider of freestanding inpatient rehabilitation facilities. It blends scale with operational agility, allowing it to innovate and adapt quickly in response to secular growth trends like an aging population.
Tractor Supply has built deep loyalty in rural markets by leveraging customer knowledge and tailoring strategy to local needs, an approach that's difficult for larger, generalist retailers to replicate or out-adapt.
And F5 Networks, an under the radar technology company with a leading position in application delivery controllers, or ADCs, which direct web request traffic to avoid overloading servers. The company has a strong competitive advantage in addressing secular trends such as artificial intelligence, datacenter, cybersecurity, cloud migration, e-commerce and high customer switching costs. F5 possesses solid market share, a strong brand and a pristine balance sheet.
Light: It sounds like these companies succeed not by being the biggest, but by being the most focused?
Pratt: That's exactly right. Their advantage often lies in execution, not sheer size. They know their markets, move quickly, and aren't weighed down by overly complex operations. That kind of focus can be just as powerful as scale, sometimes even more so.
Light: Any final thoughts for investors still hesitant about allocating to mid-caps?
Pratt: I'd encourage them to reconsider how they view mid-caps. These companies aren't just filler between small and large. They can be foundational holdings. With the right approach, mid-caps can bring balance, diversification, and resilience to a portfolio. And as the market evolves, ignoring them could mean missing out on some of the most compelling opportunities out there.