Course 405: Mid-Cap Funds: The Small-Cap Substitute?
Mid-Cap Stocks: What They Are
In this course
1 Introduction
2 Mid-Cap Stocks: What They Are
3 Why Small Caps Haven't Worked Well
4 How to Use Mid-Caps

Of all the parts of the Morningstar style box, none is so nebulous as the strip labeled mid-cap. Everyone recognizes a large-cap company: That’s Coca-Cola KO or IBM IBM. Little-known small-cap firms also have an identity: They are the entrepreneurial startups that may turn into giants tomorrow. But what, exactly, are mid-cap companies?

Perhaps the best way to get a handle on the mid-cap universe is to view it as a collection of the most successful small-cap stocks and the least successful large-cap stocks. Small-cap companies that grow become mid-cap companies. That type of mid-cap company would still be a rapidly growing firm, but would have less operational risk (in other words, it would be less likely to go bankrupt) than a smaller company. Meanwhile, large-cap companies whose stock returns don’t keep pace with their peers’ returns will eventually slip into mid-cap range. That type of mid-cap could be a solid company with lackluster returns, such as tobacco giant RJ Reynolds RJR.

Intuitively, you’d expect mid-cap stocks to behave a little like small caps and a little like large caps. The numbers bear this out. Using the Russell Midcap index as a proxy, it’s possible to get an idea of how mid-caps have behaved over the past 20 years. The index’s annual returns typically fall between those of the Russell 2000 index and the S&P 500. In 2001, for example, the Russell 2000 eeked out a 2.5% return while the S&P 500 slid 11.9%. The Russell Midcap, meanwhile, was neither hot nor cold with a middling 5.6% loss. Only six years in that two-decade period did mid-caps either lead or trail both market-cap groups.

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