The magnificent middle

By: John Christy, Orbis Investment Counsellors

John Christy

A mere seven stocks have accounted for nearly all the gains in global equity markets in 2023. Strip out the so-called ‘Magnificent Seven’ – Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla – and the rest of the US stock market has been slightly negative.

This is a common pattern that has repeated throughout history. An earlier iteration of the Magnificent Seven was the ‘FANG’ stocks – Facebook, Amazon, Netflix and the company formerly known as Google. In emerging markets, the ‘BRIC’ theme – Brazil, Russia, India and China – was first floated in a Goldman Sachs report more than 20 years ago. In the 1970s, the BUNCH companies – Burroughs, Univac, NCR, Control Data and Honeywell – were the forgotten darlings of the mainframe computing era.

Whenever a small group of stocks becomes dominant, it can be a sign that opportunities are being overlooked elsewhere. Mid-cap stocks are a great example today. There is no official definition of what qualifies as a mid-cap stock, but the S&P MidCap 400 includes companies with market capitalisations ranging from about $5bn to $15bn. If we apply that same range to the global universe of stocks, we get about 1 800 potential ideas to choose from – and more like 5 000 if we widen the range to $2-20bn.

This part of the market is often a fertile hunting ground for contrarian investors. Mid-caps are big enough to take meaningful positions, yet are still small enough that they tend to be ignored or misunderstood by other investors. They may have very little to no weight in our benchmarks, bringing something different to the table that a passive approach would miss.

They are substantially cheaper as a group than their larger peers. For example, in the US, the S&P 500 trades at a price-to-earnings multiple of around 18 times, versus only 13 times for the S&P MidCap 400. Not only is this valuation gap wide, it is also a striking reversal from much of the past 20 years when mid-caps often traded at a premium to their larger cap peers.

We have found compelling opportunities in mid-caps. While we research all of them on a bottom-up basis, there are at least a few distinct themes that emerge.

The first theme would be highly idiosyncratic and entrepreneurial businesses. These are companies that started small and grew over time. It is not unusual for the founder to still be involved in some capacity and to have a significant portion of their own wealth invested alongside shareholders. Examples here include XPO, GXO Logistics and RXO – all of which trace their roots back to a single company founded by a serial entrepreneur, Brad Jacobs, who still serves as chairman of all three companies.

Another category might be termed ‘local heavyweights’. These are companies that end up in the middle only because the global equity market is so massive. This basket includes AIB and Bank of Ireland, which dominate the Irish banking system. It also includes a group of Korean financials with similarly outsized local influence: Shinhan Financial, Samsung Fire & Marine Insurance and Hana Financial. Another local heavyweight is Jardine Matheson, which controls businesses across Asia. These companies may be middleweights on the world stage, but they are not middling by any means.

While none of these shares are immune to global stock market volatility, the key variables that really matter for these businesses tend to be much more ‘micro’ in nature, usually limited to specific industry or local market developments. Through our intensive research efforts, we can get to know these companies extremely well and develop the conviction to be patient – perhaps even increasing our stake – during uncertain times.

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