2023: an entry point for Mid Caps?
Historically, Mid Caps have most often outperformed Large Caps , and this has been the case 17 times over the past 22 years.
On 26th June 2023
With their niche positions, attractive relative performance, growth and innovation, Mid Caps are clearly different from Large Caps. However, in 2022, against a backdrop of high inflation and soaring interest rates, the Large Caps indices outperformed the Mid Caps.
In our view, this was an exceptional episode, and several factors now argue in favour of Mid Caps catching up.
The performance of Large Caps in 2022 can be explained by an exceptional context. For the majority of large companies, the inflationary context of 2022 was an opportunity to increase their margins in an unprecedented way, in particular by playing on their pricing power, which also proved decisive that year. In the eurozone, the current operating margin of large caps has historically fluctuated between 8% and 12%, but reached 13.5% in 2022. This is particularly true of the commodities, energy, banking and insurance sectors, which achieved exceptional profitability in 2022. These sectors are absent from the Mid Caps universe, even though they account for almost a quarter of the Euro Stoxx 50. This was notably the case for the commodities sector, where profits almost doubled in 2022.
As a result, Large Caps’ growth in 2022 was well above their historical average. The period from 2013 to June 2021 accounts for only 43% of the growth in net income generated on average by Large Caps over the last ten years, the rest (57%) having been generated over the last 18 months!
We believe that the Mid Caps valuation premium should recover. The current valuation of Mid Caps is empirically low and is at the same level as that of Large Caps, whereas historically Mid Caps have enjoyed a premium of around 20 to 30% due to their higher growth. This lack of premium implies that the long-term growth of the two asset classes should be identical, but history shows that Mid Caps grow faster.
Historically, Mid Caps have most often outperformed Large Caps (see chart below), and this has been the case 17 times over the past 22 years. In 2022, the Mid Caps’ underperformance of around 8% followed the historical pattern of asymmetry: when the Large Caps outperform the Mid Caps, the amplitude is less than 10%, whereas when the Mid Caps outperform, the amplitude can reach 15 to 25%.
Over the long term, earnings momentum is consistent with market returns: the outperformance of Mid Caps over the last 22 years is fundamental in nature. In fact, over the last 10 years, earnings growth in Mid Caps has been almost three times higher than in Large Caps (8.9% compared with 3.4% per annum respectively), which explains the outperformance of Mid Caps over long periods.
Mid Caps have the advantage of being more agile, innovative and having a highly committed shareholder base. There are a large number of family-owned companies in this asset class, which take a long-term view and make decisions whose impact can be appreciated over time.
Mid Caps investing has been Groupama AM’s expertise since 1994.
Our management is based exclusively on stock-picking and focuses on selecting innovative, niche-leading companies with business models that create value over the long term.
Through independent and rigorous analysis, we identify companies that we believe have strong growth potential and robust fundamentals: the companies we invest in have fundamental characteristics that are above average for the Mid Caps asset class (growth, profitability, net debt, etc.).
At Groupama AM, we believe that it is within the Mid Caps that we find the nuggets that are inventing the business models that will drive tomorrow’s growth.
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