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. Given investor concerns about rates staying higher for longer, the level and durability of earnings will become increasingly important.
What this means for your portfolio
Especially after the past several years of mega-cap stock gains, you may have a greater percentage of your equity portfolio invested in large-cap stocks. Quality SMID-cap stocks offer not only the prospect for long-term growth, but also the potential portfolio diversification benefits from investing across the market-cap spectrum.
How much might you consider allocating to SMID-cap stocks? We believe that allocating around 5%–10% of an overall equity portfolio to SMID-cap stocks, assuming an appropriate time horizon and risk tolerance, can be additive to risk-adjusted returns. In other words, a small shift can make a meaningful difference.
Rick Barragan is the Managing Director,
Los Angeles Market Manager, for J.P. Morgan Private Bank.
[email protected] | (310) 860-3658
privatebank.jpmorgan.com/los-angeles
Source: J.P. Morgan Private Bank, June 14, 2024 Are overlooked small-and mid-cap stocks about to surge? By Sitara Sundar, Equity Specialist, J.P. Morgan Private Bank.
