Latest / Stock Picking with Fexingo: Individual Equities, Research, and Building a Concentrated Portfolio / Why The Selloff In Big Tech Makes Mid-Caps More Attractive
Transcript
- Lucas: So the S&P 500 is at 7,431 today, which sounds healthy, but under the hood the last five trading days tell a different story. The Nasdaq is down slightly, and Apple, Microsoft, Amazon, Meta — each of them lost between 1 and 5 percent in just the past week. Meanwhile the Russell 2000 is up more than 3 percent. That's a pretty clear rotation signal. Luna: Yeah, small caps are getting some attention. But I keep hearing the Russell is still full of unprofitable companies. Is that rotation really sustainable? Lucas: It's a fair point. The Russell does have a lot of low-quality names. But the rotation isn't just small caps — it's also mid-caps. Companies between, say, 10 and 50 billion in market cap, many of which have strong business models and real free cash flow. They've been ignored while everyone chased the Magnificent Seven. Luna: Give me a name. Who's actually interesting in that range right now? Lucas: Copart. Market cap around 54 billion, so it's at the high end of mid-cap. They run online vehicle auctions — mostly salvaged cars from insurance companies. The moat is surprisingly wide: they have hundreds of physical storage yards, a massive buyer network of dismantlers and exporters, and a proprietary auction platform. It's hard to replicate. Luna: I've heard of them. They're not a household name, but the numbers are pretty consistent, right? Lucas: Exactly. Revenue has grown at about 12 percent compound annual growth rate over the past decade. Operating margins are in the low 30s percent range. Return on invested capital is consistently above 20 percent. It's a classic compounder that flies under the radar because it's not in the S&P 500 — it's in the S&P MidCap 400. Luna: So the index effect could actually work in its favor. As more money flows into mid-cap ETFs, Copart gets a natural bid. Lucas: That's part of the thesis. The other part is that the business is resilient in a downturn. When car accidents happen, insurance companies need to liquidate vehicles quickly. Copart's auction model is the most efficient outlet. So it's not as cyclical as you might think. Luna: Alright, what's another one? I want something maybe a little more consumer-facing. Lucas: Williams-Sonoma. The parent company of Pottery Barn, West Elm, and the Williams-Sonoma brand. Market cap around 20 billion. They've been written off as a pandemic winner that would fade, but the numbers tell a different story. Luna: I think I saw their latest quarterly numbers. Revenue was flat year-over-year, but earnings per share grew by a decent clip. Lucas: Right. Revenue flat at about 2 billion in the most recent quarter, but operating margin expanded by over 200 basis points to about 17 percent. How? They've been aggressively buying back stock — share count down about 4 percent year-over-year — and they have a massive supply chain advantage. They own their own logistics network, so they can deliver large furniture profitably when competitors can't. Luna: So it's a capital allocation story. You get a company that generates a lot of free cash flow and returns it to shareholders without taking on debt. Lucas: Exactly. Free cash flow yield is around 15 percent right now. That's extraordinary for a retailer. And management has been disciplined: they don't chase growth for its own sake. They're willing to let underperforming product lines go and focus on what works. Luna: And both Copart and Williams-Sonoma have something in common — they're not in the conversation about AI or tech disruption. That might actually be a good thing if the rotation continues. Lucas: It's funny you say that, because that's part of why we do this show ad-free. We want to talk about ideas that aren't just whatever the market is screaming about. And if you find that approach useful, there's a simple way to support it: buy me a coffee dot com slash fexingo. No pressure, just if you feel like it helps keep these conversations going without any sponsor noise. Luna: Yeah, it's a small thing that makes a big difference. And we really mean it when we say the show stays ad-free because of listeners who chip in. So thank you to anyone who does. Lucas: Alright, back to the rotation. Let me add one more dimension: valuation. Copart trades at about 30 times earnings, which is not cheap, but if you look at its price to earnings to growth ratio, it's around 1.5. That's reasonable for a business with its consistency. Williams-Sonoma trades at about 12 times forward earnings. The market is pricing it like a declining retailer, but the data suggests otherwise. Luna: So the risk with Copart is valuation multiple compression if growth slows. And for Williams-Sonoma, the risk is housing downturn or consumer weakness hitting furniture sales. Lucas: Those are real risks. But the beauty of mid-caps is that they're big enough to have institutional coverage, yet small enough that they're not overowned. You can build a concentrated portfolio of 15 to 20 of these names and get diversification without sacrificing quality. Luna: Are you noticing any common threads in the mid-caps that are outperforming this month? Beyond just the rotation. Lucas: A few. High free cash flow conversion, low debt, and pricing power. Also, companies that are beneficiaries of onshoring or infrastructure spending. For example, Quanta Services is a mid-cap that builds electrical grid infrastructure. With all the data center buildout, demand is surging. That stock is up about 18 percent year-to-date. Luna: Right, Quanta is in the S&P MidCap 400 as well. So they benefit from the AI infrastructure theme without being a pure tech company. Lucas: Exactly. And that's a theme that has legs beyond just this quarter. The grid needs to be modernized regardless of what the Fed does with rates. Luna: Let's talk about the index effect you mentioned. The Russell 2000 had that big rebalancing this month, right? That can create temporary dislocations. Lucas: Yes, the annual reconstitution was just completed on June 12. So some stocks got added or removed, and passive funds had to adjust. That can create buying pressure for newly added names. But the more structural shift is that active managers are starting to look beyond mega-cap tech for returns. Luna: Because the gap in performance between the top five stocks and the rest of the market has been extreme. At one point this year, the top five made up over 25 percent of the S&P 500. That's a concentration risk. Lucas: Right. And when you see the Nasdaq down slightly over the past week while the Russell is up 3 percent, that's a signal that the trade is unwinding. Not necessarily a crash, but a rotation. And rotations can last for quarters. Luna: So for an individual investor, how would you approach building exposure to mid-caps? ETFs or individual stocks? Lucas: I'd start with individual stocks if you have the time to research. The mid-cap ETF, like the S&P MidCap 400 ETF, ticker I-J-H, is fine, but it owns everything — including the laggards. If you pick 10 to 15 high-quality names, you can outperform. But you have to do the homework. Luna: And the key is to avoid companies that are just cyclically cheap. You want businesses with durable competitive advantages. Lucas: Exactly. That's why I focus on return on invested capital. Copart's ROIC is over 20 percent. Williams-Sonoma's is around 30 percent. Those are numbers you rarely see in large-cap indexes. Luna: I've been looking at the data for this episode and noticed that the value-oriented ETFs like i w d and V-T-V are up about 2 percent in the past five days, while growth-heavy funds are flat to down. That's another piece of the puzzle. Lucas: Yeah, value is having a moment. And mid-caps often straddle the line between value and growth. You get a little of both. That's the sweet spot. Luna: So to sum up: mid-caps with high ROIC, strong free cash flow, and secular tailwinds — like Copart in online auctions and Williams-Sonoma in premium home goods — could benefit from the rotation out of mega-cap tech. And the index effect from ETF flows adds a tailwind. Lucas: That's the thesis. It's not a guarantee, but the odds are better than chasing momentum in the big names right now. And as always, you have to be patient. Rotations don't happen in a straight line. Luna: Alright, good conversation. Next episode we'll dig into another angle. Thanks for listening, everyone. Lucas: Yeah, see you next time.