BUSINESSWEEK ONLINE : NOVEMBER 20, 2000 ISSUE
FINANCE

Investors Are Finding Midcaps Just Right
As small caps crawl and large caps totter, midcaps look good

Midcap stocks have been anything but middle-of-the-road investments this year. The Standard & Poor's MidCap 400 Index has leapt 19% through Nov. 7, pulling ahead of the 3% losses in the large-cap S&P 500-stock index, and trouncing the tech-laden Nasdaq, which has shed about 16% so far this year.

While the market correction this fall may have burst the bubble in Nasdaq and S&P-500 stocks, it has done little to derail midcap companies like Polycom Inc., a high-tech communications outfit, biotechs including IDEC Pharmaceuticals Corp., and energy companies such as Calpine Corp.--stocks that are registering triple-digit gains so far this year.

The reason these meat-and-potato companies keep chugging along: earnings. The S&P MidCap 400 companies will clock 17% earnings growth for the fourth quarter and 15% for the first quarter of 2001, according to consensus estimates. That far outpaces fourth- and first-quarter earnings estimates of about 11% for large caps, which have been prone to more than the usual number of downward revisions this year. Earnings projections for just technology stocks are also way down to 17% from 29%, where they were on Oct. 1. That's ''one hell of a drop,'' says Charles L. Hill, director of research at First Call Corp.

Institutional investors in midcap companies say the best thing about the sector is not what has already happened--but what could be in store. For one thing, they are relatively cheap compared with their big brothers. The average price-earnings ratio for the S&P MidCap 400 is 19.2 vs. 22.6 for the large-cap S&P 500. Says William C. Nygren, portfolio manager of the $2 billion Oakmark Fund: ''Their prices don't reflect the great futures they have ahead of them.'' And with the crack in Nasdaq stocks, there's renewed investor interest in fundamentals, rather than on momentum investing that was typical when the Nasdaq was soaring.

But it's not only earnings and valuations. Most midcap companies are seasoned and have more liquidity than small-cap stocks, which are up only 1% so far this year as measured by the Russell 2000 Index. Also, they can grow much faster than lumbering large-cap stocks. Midcap companies are roughly between $1.6 billion and $11 billion in market capitalization.

''HOTTEST CLASS.'' Investors seem to be buying the argument for midcap growth stocks. And that should push their prices even higher. Midcap-growth mutual funds grabbed $49 billion through September, upping assets 42%. Although large-cap growth funds attracted $87.1 billion in new money, it increased assets in the category by only 12%. ''Investors are moving to tap into the hottest asset class,'' explains Chris J. Brown, director of research at Boston's Financial Research Corp. ''And midcap growth is certainly hot.''

Fund companies, hoping to feed investor appetite, have already launched about 20 new midcap funds this year, and more are sure to follow. One of the newest, Montgomery Funds' Mid Cap 20 Portfolio, will invest in none other than health-care, biotech, and high-tech companies. ''There's still a lot of opportunity in these industries, despite the recent blowups,'' says co-manager Paul LaRocco.

Peter I. Higgins, manager of $3 billion in midcap stocks, including the Dreyfus Midcap Value Fund, which is up 33% this year, holds 30% of the fund's assets in tech stocks and 20% in consumer services, especially retail. He expects his holdings, including Quantum Corp., Lam Research, and Parametric Technology to continue to outperform the market. ''The whole idea that there was Amazon and nothing else has been proven false,'' Higgins says. ''I think it's safe to say that these midcap stocks will more than hold their own, if not outperform.''

The rally in large-cap stocks has fueled the bull market. With that momentum slowing, it looks like investors in midcap stocks may still be in the middle of something big.

By Mara Der Hovanesian in New York

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