IJH: Mid-Caps Offer High IRR Potential And Possible Outperformance

seekingalpha08-13

IJH is an ETF providing exposure to U.S. mid-cap stocks with assets under management of $85.1 billion, and positive net fund flows.The fund replicates the S&P MidCap 400 Index with a balanced ...

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Recently, I covered OEF, a popular fund that invests in the \"S&P 100\" (essentially the 100 largest U.S. companies). IJH, on the other hand, is based on the S&P MidCap 400 Index, the fund's benchmark index, which is constructed to include companies with an unadjusted market cap of $6.7 billion to $18 billion (per S&P's most recent USD factsheet, as of July 31, 2024). IJH is an effective way to replicate the performance of this 400-company U.S. equity index, with a reported expense ratio of 0.05%, per iShares. As of August 9, 2024, iShares reported that IJH had assets under management of $85.1 billion, which would indicate a high level of popularity. This follows a year of positive net fund flows of circa $3 billion (see below).   ETFDB.comI last covered IJH in June 2022, in which my base IRR estimate was 13.37% per year. Per Seeking Alpha data at the time of writing, the compound total annual growth rate is 12.38%, making my IRR estimate seem fair in retrospect. However, since then, the S&P 500 index has apparently risen on a non-total return basis (i.e., before dividends/reinvested) of 16.38%, supported in no small part by the largest companies in the S&P 500 (in which OEF, as mentioned earlier, invests more heavily). I think it is nevertheless worthwhile reviewing IJH to see if there is relative value opportunity at present, especially considering my OEF IRR estimate as of recent (as a reference point) was about 11% in my base case. Portfolio and Sector Exposures As noted, IJH seeks to replicate the S&P MidCap 400 Index. Accordingly, there are about 400 holdings (406 to be precise) as of August 9, 2024 (several companies have multiple share classes; the typical cause of the nominal difference in equity index constituents and ETF tracker holdings). Unlike the top-heavy funds above the mid-cap level, where a kind of Pareto principle or power law seems to naturally apply, in the mid-cap range you tend to have far greater fragmentation across both companies and sectors. Some investors will like this, as it lends to far greater diversification. The top 10 holdings in the IJH portfolio are shown in my table below, with an overall top 10 concentration of 6.48%.   Data from iShares.comThis makes IJH not dependent on any single or collection of stocks. On the portfolio-wide level, the fund strikes a balance across most sectors, with no particular bias, as shown in the chart below. If one were to break these down into their main categories of Cyclical, Sensitive, and Defensive, you have a split of 44.57%, 38.54%, and 16.9%, respectively.   Morningstar.comSo, one could conclude that on balance IJH is likely to exhibit \"economic beta\", and on a market beta basis, I calculate the three-year, monthly beta (relative to the S&P 500) as being 1.17x, which sort of lends to a slightly riskier perception among investors relative to the broader market. Valuation As cited earlier, the most recent factsheet as of July 31, 2024, for the fund's benchmark, is a good unbiased starting point for consensus expectations of the fund's earnings and near-term forecasted earnings. The factsheet reports trailing and forward price/earnings ratios of 24.53x and 16.36x, respectively, with a price/book ratio of 2.52x and an indicative dividend yield of 1.47%. These figures imply a return on equity of 15.40% on a forward basis, with a very large EPS growth in the first year of 49.94%, though this being presumably based on a lower earnings base in aggregate in the prior year. With inflation levels beginning to normalize, mid-cap companies are likely to exhibit more stable earnings growth going forward, but the \"economic beta\" mentioned earlier is relevant. The unrestricted market-cap-weighted indices like the S&P 500 tend to be over-weight \"outsized winners\" with pricing power, so earnings can often both grow quickly and hold up strongly (if measured on a margin basis). Mid-caps tend to have less pricing power, and are more likely to be subject to economic vicissitudes. Nevertheless, the longer-term return on equity is a good barometer, and useful for making projections. Three- to five-year average earnings growth rates are expected to be around 11.87% per Morningstar's consensus analyst estimates. However, Morningstar (unlike S&P, a less subjective source) tends to adjust its earnings figures for ETFs for various items. So, this figure is likely less comparable given the one-year earnings jump we are seeing per S&P as a forecast over the next year. What we can say, however, is that Morningstar expect apparently strong earnings growth for the IJH portfolio over the next five years. After year one, I will take a more conservative view of a moderating return on equity (from 15.40% as projected by S&P, down to sub-13% by year six). The one- to five-year average earnings growth subsequently arrives at a much softer 6.74%, or 8% between years one and three (midpoint: 7.37%). Holding other factors constant, like the rate of dividends, and the earnings multiple (in calculating, for example, the terminal value in year five), the implied IRR is 13.66% for IJH in my base case. This also includes the expense ratio and minor bid/ask spread (median: only 0.02% on a 30-day basis, given IJH's high level of popularity and thus liquidity).   Author's CalculationsAs compared to my previous coverage back in June 2022, and in spite of strong performance since then, IJH still seems to provide a similar level of return going forward. While it is typically explained that past performance is no guarantee of future results, and that is of course true, it would seem as though recent performance may well be an indication of IJH's potential going forward. Further, it would seem as though IJH is possibly even better positioned than the mega-cap heavy fund OEF I covered recently. Mid-caps, with a little higher volatility relative to the broader market, may be more sensitive to economic and market surprises. On the other hand, while I calculate downside-only beta of 1.06x (indeed, slightly more volatile on the downside than the S&P 500), its upside beta is 1.26x on a three-year basis, so there is positive (favorable) skewness.  I think investors will likely do reasonably well with IJH at present prices, with an IRR potential of over 13%. Risks are going to be mainly tied to the U.S. economy's health. While we can talk about otherwise abstract risks at present, such as the potential for war, or some other macro factor not yet known, I don't perceive mid-cap stocks as being considerably more exposed than larger-cap stocks except in the event macro factors drive up supply-side (or \"cost-push\") inflation. In a more benign environment, IJH is likely to perform well, and seems to have the potential to out-perform more top-heavy funds in spite of a lower average portfolio return on equity (given present prices).","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"0","news_tag":"","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2459746549"}