Home / Equities / Value matters: Mid-cap market ready to take off as top end gets heavy

Historically, periodic outperformance by a cohort of stocks linked by sector or region – often with a catchy moniker – has been a mainstay. As has that group's inability to maintain dominance over the long term.

While global equity markets have surged in the last decade on the back of outperformance by a handful of ubiquitous technology stocks, an overabundance of faith in past performance is a poor man’s portfolio driver.

Historically, periodic outperformance by a cohort of stocks linked by sector or region – often with a catchy moniker – has been a mainstay. The performance of so-called ‘Magnificent Seven’ stocks (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla) was nothing short of remarkable in 2023, just as its predecessor, the so-called ‘FANG’ stocks (Facebook, Amazon, Netflix and Google) was before that.

Twenty years ago it was the ‘BRIC’ theme, with emerging markets in Brazil, Russia, India and China leading the pack. Before that, in the 70s, you had the ‘BUNCH’ companies of the early computing era and the ‘Nifty Fifty’ US blue chips.

According to Orbis Investment Management, it’s a trend we’ve seen before and will see again. High-performing companies or sectors are grouped together, become market darlings and consequently overvalued as fundamentals give way to hype.

*Read Orbis Investments’ whitepaper ‘Sunrise on Venus: Investing for the Next Decade’ here.

Yet this dynamic does present those who possess a different, value-based mindset, with an opportunity. “Investors have limited capital and limited attention spans, so whenever a small group of stocks becomes dominant, it can be a sign that opportunities are being overlooked elsewhere,” Orbis stated in a recent web post. “Midcap stocks are a great example today.” 

According to Orbis, there is a vast swathe of companies in the mid-cap bracket that are both underpriced and undervalued. These are far from penny stocks, with companies in this bracket boasting a market capitalisation of $5 billion to $15 billion. And there are more than just a handful to select from, with about 1,800 potential companies to choose from in the US alone (and around 5,000 if the range is widened from $2 billion to $20 billion).

“No matter how you slice it, this part of the market is often a fertile hunting ground for contrarian investors,” Orbis stated, noting that these stocks are big enough to take meaningful positions in, yet still small enough for them to be often ignored or misunderstood by other investors. “They may have very little to no weight in our benchmarks, bringing something different to the table that a passive approach would miss.”

The crucial factor making these stocks attractive, Orbis notes, is that these stocks are “substantially” cheaper than their large-cap contemporaries. “For example, in the US, the S&P 500 trades at a price-to-earnings multiple of around 18 times, versus only 13 times for the S&P 400 Midcap index.”

Currently, these stocks not only present more value-based attraction, but they also offer a fundamentally more diverse clutch of industries and sectors, which should provide a measure of risk mitigation. “Whereas larger companies tend to be household names, our midcaps are an eclectic group, with businesses ranging from Asian supermarket chains to offshore oil drillers,” Orbis stated.

If the companies in this middle grouping do hold any thematic similarities, it is that that they are usually “highly idiosyncratic and entrepreneurial”, with the founders often still involved in generating organic growth within a business they still have a major stake in.

“Examples here include XPO, GXO Logistics, and RXO – all of which trace their roots back to a single company founded by a serial entrepreneur, Brad Jacobs, who still serves as chairman of all three companies. Another example is Interactive Brokers, whose founder and chairman, Thomas Peterffy, owns the vast majority of the company.”