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Pros & Cons of Buying Mid-Cap Stocks

December 17, 2020 · 5 minute read

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Pros & Cons of Buying Mid-Cap Stocks

Mid-cap stocks are shares of publicly traded companies with market capitalization of about $2 billion to $10 billion. The range also indicates where they fall in the spectrum of valuation between small-cap and big-cap (sometimes called large-cap) companies.

Because the stocks are approximations based on a company’s current value, their classification might change over time.

Here, we’ll run through some basics on the core concepts—and the pros and cons—of buying mid-cap stocks. Keep in mind that what follows is meant to inform, not advise.

Market Capitalization Investing

Market capitalization is a company’s total value: the number of outstanding shares a company has multiplied by the current price per share. For example, a company with 40 million shares selling at $100 a share would have a market cap of $4 billion.

For investing, the case can be made for small-, mid-, and big-cap stocks, but when thinking about the numbers involved—small-cap companies have a value of less than $2 billion, and large-cap companies have a value of over $10 billion—understand that the values also govern potential growth.

In other words, small-cap stocks might grow into mid-cap stocks. But a large-cap stock can only stay a large-cap stock unless the value goes down. (Investors have informally come up with valuation categories for nano cap stocks, micro-cap stocks, and mega-cap stocks, but there isn’t a broad consensus about their cutoff values.)

Either way, when investing, the hope is generally for stocks to increase in value—and the prevailing wisdom is that small- and mid-cap stocks hold appeal because they are hopefully on their way to moving to the tier above them.

Market Cap as a Basic Investor Tool

Knowing the market cap of a company can help investors compare the company to others of similar size. An investor choosing auto manufacturing stocks could look at mid-cap companies in that sector and compare how they are doing against one another.

To dig even deeper into the basics, it’s good to understand the difference between stocks and bonds. As explained in the article, bonds are “kind of like an IOU: Instead of buying a share of ownership, investors are lending money to the issuer.”

Stocks are shares people buy for their portfolios that have the potential to offer the highest gains, while bonds are generally safer.

Investing in Mid-Cap Stocks

Finding an investment strategy that makes sense for you is largely about understanding the trade-offs involved. There’s really no such thing as a sure thing in finance, and probably the only way to think about the “best” mid-cap stocks is to look for ones that will offer a return on investment—and ideally a large one, sooner rather than later.

Beyond that, here’s a look at a couple of possible advantages and disadvantages of investing in mid-cap stocks.

Growth, Earnings, Capital

Pro: Whether mid-cap stocks are the sole investments being targeted for a portfolio or they’re part of a more diverse selection, a good argument for them is that they are often companies that are trying to expand.

These are established companies in industries that are experiencing rapid growth or are expected to. And thanks to that growth, the average mid-cap company’s earnings often grow at a faster rate than the average small cap, and with less volatility and risk.

Most mid-cap companies are small caps that burgeoned, and some are on their way to becoming large-cap businesses. Growth eases the ability to access financing to fuel expansion, so mid-caps typically have an easier time obtaining financing than small caps do.

Investing in mid-cap stocks can be the happy medium between small-cap growth and large-cap stability.

Con: Mid-cap stocks can be more vulnerable than large-cap ones. Being middle tier, by definition, means such companies don’t have as much capital to sustain them through downturns as big-cap companies do.

And because they are also not massive companies like large-cap companies with a value over $10 billion, it also means they are not as diversified as bigger-cap companies. If the market for that company disappears, the company is also at risk.

Performance

Pro: Because $2 billion to $10 billion is a sizable range of valuations, it means that mid-cap stocks often outperform large- and small-cap stocks just because it’s a markedly wide net of stocks.

The S&P MidCap400 , “a benchmark for mid-sized companies… designed to measure the performance of 400 mid-sized companies, reflecting the distinctive risk and return characteristics of this market segment,” published a report in June 2019 that indicates that “while mid-caps were about 15% more volatile than large caps, the S&P MidCap 400’s higher returns more than compensated over longer periods.”

To help put numbers to that, the S&P MidCap 400 has a September 2020 fact sheet that indicates an annualized return on investment performance of 10.49%.

Con: Risk is risk, and even those who don’t dabble in investing likely know that something that seems low risk isn’t the same as something that is not a risk. It doesn’t matter how many reports you read—there are always exceptions.

Still, reading up on investment strategies is a good idea, like this guide on how market capitalization affects stock price, which breaks down why these types of investments are often risky and how to begin investing with that knowledge in mind.

That article is full of helpful pointers, like remembering that “stock value” is not the same thing as “stock price.”

Researching Mid-Cap Stocks

Many mid-cap companies are household names. A list of the S&P MidCap400 companies can be found at Barchart , a data and technology solutions company in the financial industry.

It’s best for anyone interested in investing in mid-cap stocks to do their homework and not just follow a tip that sounds good. Look at who’s running the company, who’s already invested, and what the stated goals in articles or press releases indicate.

And it might be smart to consult a financial adviser.

Rather than developing tunnel vision for stock picks you think might need to be acted on immediately, one concept to bring up when speaking with a financial adviser is opportunity cost: what must be given up to obtain something that’s desired.

It’s tempting to think of a “hot tip” as something you must rush to get in on, but it’s worth taking a breath and considering what you might be overlooking by fixating on something that seems lucrative but also requires urgent action.

Articles are published daily about which stocks are the “best” and “worst,” but those should not be the sole factor in investing decisions.

For those who are curious to learn more, in addition to the S&P MidCap400, there are also indices for small-cap stocks (the Russell 2000 ) and large-cap stocks (the Wilshire 5000 ).

The Takeaway

Market capitalization is a way for investors to understand the value of different companies and compare their performance and outlook. Mid-cap stocks—which can be seen as lying between small-cap growth and big-cap stability—are one investment strategy to consider.

Investors can buy and sell stocks commission-free with SoFi Invest.® Or invest in exchange-traded funds. Unlike traditional ETFs, SoFi ETFs weigh companies by growth, not just market capitalization.

Put your financial goals in action with SoFi Invest.


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