While almost all investors know and have exposure to large-cap stocks in their portfolios, mid-cap stocks don’t always get as much attention. This is unfortunate as there are plenty of great mid-cap companies out there, and the SPDR Portfolio S&P 400 Mid Cap ETF (NYSEARCA:SPMD) is an effective, low-cost way to invest in over 400 of them.
I’m bullish on mid-cap stocks and SPMD as the way to invest in them, given that they have underperformed their larger peers this year and because they trade at a cheaper valuation (collectively) than their larger counterparts.
What is the SPMD ETF’s Strategy?
SPMD is an ETF from State Street that “seeks to offer precise, comprehensive exposure to mid cap US equities.” While the well-known S&P 500 (SPX) is an index of 500 of the largest publicly-traded companies in the U.S., and the S&P 600 makes up the smallest 600 companies in the S&P 1500 Index, the S&P MidCap 400 (the index SPMD follows), is made up of the 400 companies in the middle of these two ends of the spectrum. These stocks typically have market caps between $5.2 billion and $14.5 billion.
The Case for Mid-Cap Stocks
There has been no shortage of hand-wringing that the market may be getting frothy after large year-to-date gains for major indices like the S&P 500 and the Nasdaq (NDX), which are up 14.4% and 30.3% in 2023, respectively. A large portion of these gains have been driven by the “Magnificent Seven” — mega-cap tech stocks like Nvidia (NASDAQ:NVDA), Meta Platforms (NASDAQ:META), and Tesla (NASDAQ:TSLA), which are up 222.0%, 159.7%, and 135.8%, year-to-date, respectively.
In a recent interview with CNBC, Neil Hennessy, the chief market strategist for Hennessy Funds, spoke about this dynamic, pointing out, “If you look behind the curtain, eight companies have been driving that success…eight out of 3,000 stocks have been controlling the Nasdaq, which is 3,000 companies.”
Whether these rallies are overdone or not can be debated, but no such froth exists in the mid-cap portion of the market. SPMD has posted a total return of just 5.2% year-to-date, meaning that it hasn’t really enjoyed the same types of gains as its large-cap-focused counterparts. If things revert to the mean and money rotates out of some of the year-to-date winners, the mid-cap stocks SPMD invests in could be well-positioned to benefit.
Beyond this setup, mid-cap stocks have plenty of appeal, as they enjoy the best of both worlds as the place between large-cap and small-cap stocks. Neil Hennessy explained that mid-cap stocks are small enough that they can be acquired at a premium by large-cap companies, but they are also large enough that they themselves can engage in accretive M&A by acquiring smaller companies.
Additionally, mid-cap stocks look attractive compared to their large-cap peers on a valuation basis. As of October 17th, SPMD had an average price-to-earnings ratio of 14.4. For comparison, the S&P 500’s P/E ratio is considerably higher at 19.8.
SPMD’s Holdings
SPMD offers investors tremendous diversification across mid-cap stocks. It owns 402 stocks, and its top 10 holdings make up just 6.4% of holdings, so there are no concerns about concentration risk here.
Below, you’ll find an overview of SPMD’s top 10 holdings using TipRanks’ holdings tool.
While they often don’t get the same love as large-cap companies that are household names, there are some great companies among SPMD’s top holdings.
For example, Builders Firstsource (NYSE:BLDR) and Watsco (NYSE:WSO) both feature ‘Perfect 10’ Smart Scores. The Smart Score is a proprietary quantitative stock scoring system created by TipRanks. It gives stocks and ETFs a score from 1 to 10 based on eight market key factors. A score of 8 or above is equivalent to an Outperform rating.
Builders Firstsource manufactures and distributes building materials for the housing market and has returned 80.8% year-to-date. Watsco distributes air conditioning, heating, and refrigeration equipment and has gained 51.6% in 2023. Other intriguing holdings include Super Micro Computer (NASDAQ:SMCI), Hubbell (NYSE:HUBB), and Deckers Outdoor (NYSE:DECK).
Super Micro Computer is a high-flying tech stock that develops and makes high-performance server and storage solutions. It has gained 247.8% in 2023 so far and has an Outperform Smart Score rating.
Hubbell also features an Outperform-equivalent Smart Score of 9 out of 10 and sells electrical products and wiring. Shares of Hubbell are up 27.8% YTD.
Meanwhile, Deckers Outdoor is the parent company of popular footwear brands like UGG, Hoka, and more. Deckers Outdoor has returned an impressive 33% this year.
Dirt-Cheap Expense Ratio
Another great thing about SPMD is its dirt-cheap expense ratio of just 0.03%. There aren’t many funds out there that feature expense ratios this low — an investor allocating $10,000 to SPMD today would pay just $3 in fees in year one. Over the course of a 10-year investment, this investor would pay just $39 in fees, making SPMD a cost-effective building block for investors to include in their portfolios.
Is SPMD Stock a Buy, According to Analysts?
Turning to Wall Street, SPMD earns a Moderate Buy consensus rating based on 298 Buys, 91 Holds, and 14 Sell ratings assigned in the past three months. The average SPMD stock price target of $52.51 implies 22% upside potential.
The Takeaway: Don’t Overlook Mid Caps
While it’s sometimes easy to overlook, don’t forget about the middle of the market. The mid-cap stocks that make up SPMD’s investment universe are big enough to weather an economic storm and to make accretive acquisitions, but they’re also small enough that they can be acquisition targets for the bigger fish in the market.
These mid-cap stocks are yet to truly join in on the 2023 market rally, and they collectively trade at a cheaper valuation than large-cap stocks, giving them plenty of room for potential upside ahead. SPMD is a diversified and cost-effective way to invest in this theme and an interesting option for investors to consider adding to their portfolios.
