It’s no secret that the big tech stocks have racked up great returns in recent times. But for investors who think this theme may be overdone and want to pivot to opportunities beyond the usual suspects, there are plenty of promising choices in different segments of the market, such as the high-quality mid-cap stocks that the Invesco S&P MidCap Quality ETF (NYSEARCA:XMHQ) provides exposure to.
I’m bullish on this $4.4 billion ETF from Invesco (NYSE:IVZ) based on the impressive track record it has built over the past three- and five-year time frames. I’m also bullish because it goes well beyond the usual names to give investors exposure to a diverse group of stocks that are quietly establishing themselves as market winners.
Investment Methodology
According to Invesco, the fund’s sponsor, XMHQ invests in the S&P MidCap 400 Quality Index, “a modified market capitalization-weighted index that holds approximately 80 securities in the S&P Midcap 400® Index that have the highest quality scores, which are computed based on a composite of three proprietary factors.”
XMHQ defines high quality as “companies that seek to generate higher revenue and cash flow than their counterparts through prudent use of assets and finances.”
XMHQ considers three factors when building its group of holdings: the companies’ returns on equity, accruals ratios, and financial leverage ratios.
XMHQ uses these three factors to create a quality score for each of the stocks within the S&P 400 MidCap Index and then invests in the top 80 stocks.
These 80 stocks are weighted by their quality score multiplied by their market cap, and stocks with higher scores “receive relatively greater weights.” The mid-cap stocks in the fund currently have market caps ranging from $3.0 billion to $20.1 billion. It’s a relatively complicated investment process, so let’s see how it plays out in real life in the next section.
Market-Beating Performance
XMHQ’s strategy of investing in high-quality, mid-cap stocks has made it a long-term winner. As of February 29, XMHQ has produced a three-year annualized return of 13.5% and an even more impressive five-year annualized return of 17.3%. XMHQ’s results beat those of the broader market over both time frames. For comparison, as of the same date, the Vanguard S&P 500 ETF (NYSEARCA:VOO) produced an annualized return of 11.9% over the past three years and 14.7% over the past five years.
Over the past 10 years, XMHQ’s returns have been more in line with those of VOO. XMHQ has returned 12.5% on an annualized basis over the past decade, while VOO has returned 12.7% on an annualized basis.
High-Quality Holdings
XMHQ offers a nice level of diversification with very little concentration. The fund owns 77 stocks, and its top 10 holdings account for just 28.3% of assets. Below, you’ll find an overview of XMHQ’s top 10 holdings from TipRanks’ holdings tool.
Some investors and market observers have decried the fact that the “Magnificent Seven” and mega-cap tech stocks, in general, have taken up much of the oxygen in the market. And while these stocks have indeed done well, there is plenty of opportunity beyond them and a wide variety of other stocks that are quietly generating great returns, and XMHQ gives investors exposure to a nice cross-section of them.
There are many excellent stocks here that have flown under the radar of many investors but have produced phenomenal returns over the past year. For example, the top holding, furniture and home goods provider Williams-Sonoma (NYSE:WSM) has generated a fantastic 171.4% gain over the past year. Similarly, another top 10 holding, energy drink maker Celsius Holdings (NASDAQ:CELH), has returned an awesome 179.8% gain over the past year.
I like the fact that XMHQ enables investors to tap into a diverse group of less-discussed mid-cap stocks that are generating scintillating returns. For investors who are concerned that the Magnificent Seven and mega-cap tech stocks may be tapped out and are looking to diversify beyond them, XMHQ is a way to invest in a different group of the market’s winners like Williams-Sonoma and Celsius Holdings.
Another thing that I really like about these types of high-quality mid-cap stocks is that, as mid-cap stocks, they are often at an earlier stage of their growth journey and, thus, potentially have more room for growth ahead of them than mega-cap stocks.
This is just an example, but for argument’s sake, it will likely be easier for a stock like Celsius Holdings, with a market cap of below $20 billion, to double over the next few years than it will be for a stock like Apple (NASDAQ:AAPL) or Microsoft (NASDAQ:MSFT), which have market values of $3.1 trillion and $2.6 trillion, respectively, to do so.
XMHQ is fairly well-diversified by sector, with information technology making up just 9.4% of the fund. The largest sector by weighting is industrials (at 31.9%), followed by consumer discretionary (15.8%) and financials (14.9%).
Is XMHQ Stock a Buy, According to Analysts?
Turning to Wall Street, XMHQ earns a Moderate Buy consensus rating based on 53 Buys, 25 Holds, and zero Sell ratings assigned in the past three months. The average XMHQ stock price target of $111.31 implies 1.8% upside potential.
Is XMHQ Stock a Buy, According to Analysts?
With an expense ratio of 0.25%, XMHQ is pretty reasonable when it comes to cost. This expense ratio means that an investor who puts $10,000 into XMHQ will pay $25 in fees annually. While this is more than the minuscule fees charged by some broad-market index ETFs, it is still less than half the average fee for all ETFs (currently 0.57%).
Many Ways to Win in the Market
XMHQ shows that there is more than one way to enjoy market-beating gains. Investing in the Magnificent Seven has certainly been one way in recent years, but the high-quality, mid-cap stocks that XMHQ invests in have done so as well.
I’m bullish on XMHQ based on its fantastic returns over the past three and five years and its portfolio of high-quality holdings, which gives investors exposure to high-performing stocks that they won’t find in just any ETF. I believe XMHQ is a useful way for investors to diversify their portfolios beyond the typical names that you’ll find in most generic ETFs.
