Warning: Mid-Cap Stocks Extremely Overvalued Against Small and Large Caps

Credit Suisse’s U.S. Equity Strategy analyst is Lori Calvasina, and she has a warning for mid-cap investors. Her take is that mid-cap stocks currently have the highest price tag among all three groups based on market caps. The only saving grace may be that not all mid-cap industry groups are overvalued against small-cap and large-cap stocks.

Due to stronger earnings and growth metrics as a class, the big issue is that many small-cap fund managers and many large-cap fund managers also own mid-cap stocks. After all, successful small-cap stocks grow up to be mid-cap stocks. And many large-cap stocks become mid-cap stocks, or the mid-cap stocks offer enough industry leverage that a large-cap fund manager feels the necessity to own them.

Calvasina’s valuation analysis on the broader U.S. equity market now shows that mid-cap stocks are extremely overvalued relative to history. She also believes that mid-cap stocks are also overvalued versus both small-cap and mega-cap stocks.

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Calvasina said:

Mid-caps tend to see stronger earnings growth and performance than both mega caps and small caps, and, as a result, tend to be heavily owned in large cap funds as well as small and small-to-mid-cap (SMID) managers. Our valuation analysis on the broader US equity market has indicated that mid-caps are extremely overvalued relative to history (similar to small cap & large cap), and that mid-caps are also overvalued vs. both small cap and mega cap. But not all mid-cap industry groups are overvalued, and the full report identifies those that are and those that are not.

Based on forward price-to-earnings (P/E) ratio analysis, the major defensive industries and sectors look the most overvalued to Calvasina. These include utilities and telecom, health care equipment and services, and pharma/bio and life sciences. Additional areas of frothiness were shown in commercial and professional services, as well as the software and services segment.

Mid-caps look particularly pricey against mega-caps for a number of consumer groups: consumer services; food, beverage and tobacco; autos; food and staples retail; and telecom services.

Again, it is not universal that mid-caps are overvalued against small-cap or large-cap stocks. Credit Suisse’s report indicated that mid-caps still look undervalued relative to small-caps in areas that are beneficiaries of cheap oil — consumer services, retail and transportation. Other areas listed as not overly expensive were semiconductors and semiconductor equipment, as well as technology hardware and equipment.

Where mid-cap stocks look particularly undervalued against mega-cap stocks is in energy, consumer durables and apparel, commercial services, and materials.

Credit Suisse’s analysis was based on companies that are members of the Russell mid-cap index. This generated a weighed average market cap of $13.3 billion, while the largest stock was valued at $33.9 billion.

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