2 Sizzling Mid-Caps That Could Stay Hot This Summer

Key Points

• The mid-cap S&P 400 is up only 8% this year, but there are some outliers having big years. 
• InterDigital, Inc. is up 95% year-to-date after posting 100% revenue growth and 517% profit growth in the first quarter.
• Toll Brothers stock is still undervalued despite being up 89% from its October 2022 bottom.

Innovation looked quite different 40 years ago. The Internet was born. The Space Shuttle Challenger made its maiden voyage. The 3D printer was invented. Still, the tech-heavy Nasdaq Index surged 37% in the first six months of 1983.

Fast forward to this year, and that same spirit of innovation has spurred the Nasdaq Composite to a 32% run — its best first half since, yes, 1983. This time around, the excitement around artificial intelligence (AI) technologies are driving the gains. And with related mega cap names like Nvidia, Microsoft and Meta Platforms responsible for much of the Nasdaq’s climb, the rich are getting richer. 

While the Nasdaq-100 is up 40% this year, the mid-cap S&P 400 is up only 8%. The small-cap S&P 600 is up 5%.

The year-to-date performance disparity between large and small companies puts the spotlight on asset allocation. Portfolios that are overweight with tech-heavy, large-cap ETFs and stocks are outperforming. Those with significant small-mid cap weight are lagging. 

The widening gap is about more than AI and tech. Smaller companies tend to struggle more in weakened economies compared to deeper-pocketed large ones. They are more growth-oriented and therefore thrive in strong economies. Plus, higher interest rates tend to have a disproportionate impact on smaller companies, carry more risk in the eyes of lenders and therefore, face greater borrowing costs. 

Put it all together, and it makes sense that roughly 40% of S&P 400 stocks are in the red this year — compared to 25% in the Nasdaq-100. 

At this stage, is it better to play the hot hand or get the cold hand on sale? Perhaps neither.

Not all mid-caps are ice-cold. In fact, some are having big years. Super Micro Computer has tripled. Sotera Health and Builders FirstSource have doubled. In these three cases, though, valuations and technicals point to overbought conditions. 

Are there any less followed mid-caps that are heating up but remain undervalued? Check out these two momentum trade candidates. 

Why Is InterDigital Stock Going Up? 

Mobile technologies provider InterDigital, Inc. NASDAQ: IDCC is up 95% year-to-date. Volume increased from May to June, which bodes well for further gains. 

The company is off to a fast start in 2023 after posting 100% revenue growth and 517% profit growth in the first quarter, both of which far exceeded Wall Street estimates. Much of the outperformance relates to a favorable U.K. court ruling that forced Lenovo to pay $100.8 million for 3G, 4G and 5G patent infringements. It is also benefiting from new patent license agreements. These translate to recurring revenue growth, an attractive attribute for investors. In May 2023, InterDigital struck a deal with Alps Alpine that will cover the Japanese electronics maker’s full lineup of devices.

Management expects licensing deals with Lenovo and Samsung to remain a tailwind throughout the year. And while catch-up revenue pops won’t be the norm going forward, the U.K. High Court is still evaluating whether Lenovo owes additional interest payments tied to a six-year, $337 million licensing deal that was not made on proper terms. 

Despite trading near its 2017 all-time high, InterDigital shares are inexpensive. The 28x forward P/E ratio is well below the software industry average and the stock’s own historical average. A pair of bullish technical patterns that emerged last month — an upside breakout and a bottom triangle — also point to more upside. 

Is Toll Brothers Stock Undervalued?

Upscale homebuilder Toll Brothers, Inc. NYSE: TOL is on a nine-month winning streak — and with volume increasing in each of the last two months, it’s showing no signs of slowing down.

While peers are struggling with the housing market downturn, Toll Brothers is flourishing for several reasons. First, the affluent nature of its customer base makes it relatively immune to rising mortgage rates and home prices. And while peers have seen high lumber costs eat into profits, the company’s ‘in-house’ lumber distribution has made this a relative non-factor. In addition, Toll Brothers’ growing portfolio of apartments is benefitting from what remains one of the hottest areas of inflation — rental prices.   

Even with Toll Brothers up 89% from its October 2022 bottom, the stock is undervalued. After crushing Street expectations with 54% fiscal Q2 earnings growth last quarter, management boosted its full-year delivery forecast from 8,500 to 9,000 homes. 

The consensus estimate for 2023 EPS imputes a 7x P/E ratio that isn’t consistent with Toll Brothers’ luxury brand. It is one of the lowest valuations among mid-cap homebuilders. Look for TOL to continue building off its recent gains.