Are Overlooked Stocks About to Surge?
Mega-cap tech stocks—the market’s darlings—continue to power forward. Now, as earnings growth accelerates in a robust U.S. economy, the stock market rally is broadening beyond mega-cap tech. And it is shining a particular light on U.S. small- and mid- cap (SMID-cap) stocks. This market cohort offers the potential for long-term capital appreciation supported by durable profit growth.
A near-record discount in smaller-cap stocks may offer an opening
We prefer quality SMID-cap stocks that focus on profitability and growing competitive advantages. Some SMID-cap companies carry high levels of debt, and a valuation discount for these stocks seems reasonable. However, today’s near-record discount in the highest-quality SMID-cap stocks does not. Indeed, high-quality smaller-cap stocks now trade at a near-record valuation discount versus their large-cap peers, despite having similar cash flows and profit margins. We believe that gap will narrow, creating a potential entry point.
Durable earnings growth, strong long-term capital appreciation
Over the past 10 years, SMID-cap companies have generally grown their earnings at a faster pace than their large-cap peers. We believe SMID-cap companies will continue to deliver strong earnings growth. Our 2024 Long-Term Capital Market Assumptions estimate that U.S. SMID-cap equity returns will be robust over a 10-to-15-year investment horizon, even rivaling that of U.S. large caps (albeit with more risk). We believe building a portfolio of actively managed, attractively valued, high-quality SMID-cap companies can generate robust long-term returns while mitigating some of the risk.
An inefficient market ripe for stock picking
Selectivity is key. We note a wide dispersion in the quality of the underlying companies in the SMID-cap universe, which partly reflects the state of disruption in their businesses. Some companies either carry high levels of debt or do not generate earnings….
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