Cautious investors go with what they know. That’s why they often select blue chip stocks for their portfolios. Blue chips are high-end companies with loads of traction and lots of coverage by the financial media. Everybody’s heard of Microsoft, IBM, Proctor & Gamble – household names that are heavily traded every day.
And this is a good thing. Blue chips add ballast to any portfolio. They tend to hold their value in times when markets are making the proverbial “flight to quality” – with investors closing their positions in lesser-known stocks and moving capital into blue chips, or “quality” as the prognosticators like to call it.
Holding blue chips does add stability to your basket of stocks, but if you’ve put all of your assets in blue chips, well, you’re not going to see the major upturns made by mid-tier companies when the market rebounds – and historically, the market has always rebounded.
The Standard and Poor’s (S&P) 500 Index is a collection of well-known companies from across all industry sectors – from heavy-equipment manufacturers to bio-tech companies. The companies in this index are tracked by sophisticated computer software (computer trading) that detects signals of movement up or down. And a computer-generated buy or sell order can send the entire market in one direction or the other.
But S&P maintains other indices. One of the most important is the S&P Mid-Cap 400. Though the companies that comprise this index are lesser known, under most market conditions this is where you want to put some serious capital. The key is in detecting movements in share price before the rest of the market does. Impossible? Hardly. There are a lot of wealthy investors out there who never owned a single share of Berkshire-Hathaway (with apologies to Warren Buffet). These investors made their money investing in mid-caps.
Don’t Forget Mid-Caps
Not all blue chips stay that way. There was a time, not too long ago, when Ford Motors was considered a blue chip. Today, it closed at $3.00 a share, down 2.6% on the day. The cachet of success has long disappeared from this one-time, must-have stock.
Same with GM, once the bluest of the blue chips. “What’s good for GM is good for the country.” That used to be the street’s mantra. Not anymore.
Toyota has become the largest auto manufacturer and GM’s charts look like a ping pong ball with ‘roid rage. Price swings this year have ranged from $29.50 up to $38 and back down to close the day at $36.11, down 1.61% on the day. Not exactly the conservative growth model preferred by many self-directed investors.
In other words, blue chips just ain’t what they used to be. And what was once blue may find itself in the red very shortly.
In addition, because these major corporations are tracked and analyzed by every brokerage and trading platform, it’s unlikely that you’re going to detect a blue chip breakout before the pros do. In fact, by the time you, the individual investor, hear about the next big upside move, it’s already old news on the street and factored into current share price, up or down.
So, the involved investor (if you’re not, you should be; it’s your money) looks elsewhere for significant growth opportunities. Many turn to the mid-cap market for lots of good reasons.
Ever hear of Guess (NYSE: GES), the apparel manufacturer? It saw a jump of 104% in ’06, leading the S&P Mid-Cap 400. Other top performers? Cytyc (NASDAQ: CYTC) was up 78%. Martin Marietta (NYSE: MLM) up 66%. BorgWarner (NYSE: BWA) up a very nice 86.41%.
These are not fly-by-night, high risk investments. These are well-established companies. They have a history that can be tracked and analyzed for buy and sell signals. These are companies with high share volume each day, indicating consistent market interest and good liquidity for you, the self-directed investor.
Though on the radar of every investment company globally, these and other mid-caps don’t receive the media attention of Coke and Intel. However, the markets track these companies carefully. You just have to know what signals they use to move them to a buy or sell decision. If you can discern these trip wires early, you can earn a lot more than you’ll ever earn putting the bulk of your portfolio in blue chips. Here’s why. It’s all in the math.
Randomly selected McDonalds – a consumable goods company in thousands of portfolios. Everybody knows Mickey D. Well, today it closed at $56.01, up 2.83% on the day. Not a bad day at all.
But, let’s compare MCD against the performance of mid-cap BorgWarner. BWA showed an 86% annual gain in year ’06. For McDonalds to match that performance, it would have to go to $104.23 and we all know that’s not going to happen in the next 12 months. It’s in the percentages.
Mid-Cap Investing Made Understandable
It comes down to the well-known risk versus reward equation. The higher the risk, the higher the chances of losing money. However, if the higher-risk investment pays off as you anticipate, you make more.
Mid-caps, at least psychologically, carry with them the perception of higher risk than say, the list of 500 companies that comprise the S&P 500 Index. It’s a perception common among self-directed investors and many stock analysts. And yes, investing heavily in mid-caps does carry some increase in risk, but the rewards far outweigh the slight additional risk associated with investing in well-known, established companies like BorgWarner and Martin-Marietta.
There are investors who have developed trading models – sets of circumstance by which they measure and assess the potential for a stock buy or sell. Most are highly-risky, jet-fuelled programs that function globally.
Yet, today, to be a truly successful, professional investor it’s almost a requirement that you specialize in a particular industry or market sector. Even with the most sophisticated trading software, there’s just too much information. So professional investors develop their own trading models, based on predetermined criteria and specific to one arena.
Some choose to focus on a particular market segment – oil and gas juniors, for example. Some focus on a specific region or investment vehicle – French leaseback bonds, maybe. Other self-directed investors prefer to track market segments: there are blue-chip traders, mid-cap investors, penny stock gamblers, ETF junkies, bond brokers and so on.
Here’s the bottom line: Mid-caps tip the scales of risk versus reward in favor of the small buyer, delivering significantly bigger percentage annual returns than blue chips without the need to take on a lot of additional risk – something you would do if you decided penny stocks are the way to go. (They’re not.)
Good companies, with long-established histories, regular, reliable earnings and comfortable capitalizations. A portfolio of well-chosen, well-tracked mid-caps can outperform blue chips, value and growth mutuals, penny stocks, sector funds – you name it. These are quality companies that grow faster than the economy – and certainly faster than the 9.5% the NYSE has averaged over the past five years.
Do Your Homework
Blue chips do add ballast to a well mixed portfolio, so some portion of your assets should be in these premium quality stocks. But the real money is being made in the mid-, small- and micro-cap markets where 50% moves in a single day aren’t unusual.
Never invest without performing due diligence. Look for company reports from analysts and read the company prospectus – even the fine print.
Look for trends in volume and per share price. A stock that’s rising in share price with more shares selling everyday is one to watch, yes? You bet it is.
Move on market trends and the trend lines of quality mid-caps.
Keep liquid so you can move in at the best time.
Know when to sell. This is perhaps the hardest lesson to learn. Some sell way too early and some hang on as share price nose dives. (It’ll come back. You’ll see.)
Stay diversified. Let your quality blue chips keep the ship afloat. But add a little octane to that outboard’s engine by developing a portfolio of quality mid-caps. Great upside potential with little additional risk.
