These 4 unflashy mid-cap stocks are on track to be tomorrow's mega-caps, according to one $3.2 billion fund manager

• Lori Keith says there's one part of the market that's been overlooked this year: mid-caps.
• Mid-cap stocks offer quality and significant upside, says Keith, a PM at Parnassus Investments.

If you invested $1,000 in Nvidia just five years ago, you'd have over $27,500 today.

The key to maximizing stock-market returns is to buy in early before the hype. The Magnificent Seven have incredibly high market caps now, but they were small- and mid-sized companies before they were market behemoths.

That's why Lori Keith, director of research and portfolio manager at Parnassus Investments, is such a big fan of mid-cap stocks. Keith oversees $3.2 billion of assets in the Parnassus Mid Cap Fund. Her investment strategy centers on finding quality companies with long runways for revenue and profit growth.

Investor sentiment this year has been mainly focused on mega-caps and small-caps, with not much appreciation for the middle. But Keith believes mid-caps offer the best of both worlds. Small caps have high growth potential but are also high-risk and often unprofitable. On the other hand, large caps may have difficulty sustaining high growth rates going forward, meaning that there's limited upside.

Mid-cap companies are usually defined as those with market caps from around $2 billion to $10 billion, but Keith takes a more liberal definition, considering companies valued even over $100 billion.

"It's a really attractive place for investors," Keith said of mid-cap stocks. "There are really strong defendable businesses that often have the ability to capture additional growth relative to the large-cap stocks that are a bit more saturated."

The mid-caps with the most potential are usually not household names, Keith said. But they do have strong balance sheets with plentiful free cash flow and low debt, and often have sufficient capital to expand overseas and fund acquisitions. And most importantly, Keith is looking for companies with a differentiated product in the market, or what Warren Buffett has dubbed an "economic moat."

Under this strategy, several of Keith's picks have quickly expanded their businesses and outgrown the mid-cap label. Keith is particularly bullish on mid-caps in areas of the market such as software, semiconductors, real estate, and healthcare.

Below, she shares 4 mid-cap companies with strong long-term growth prospects and the potential to become market dominants. They are all constituents of the Parnassus Mid Cap Fund.

CBRE

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Ticker: CBRE

Market cap: $37.3 billion

Investment rationale: CBRE is the world's largest real estate investment firm and services provider for occupiers, owners, lenders, and investors across multiple types of commercial real estate categories. Keith likes CBRE for its industry-leading position, which gives it strong recurring revenues from global clients. Over 95% of the Fortune 100 utilize CBRE's services. Additionally, secular tailwinds in the real estate industry, such as decreasing interest rates and increasing buying activity and construction, will also give CBRE a boost.

Fortinet

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Ticker: FTNT

Market cap: $63.4 billion

Investment rationale: Keith added Fortinet to the fund in 2023 due to its strong growth profile and dominance in the network security space. Fortinet offers products such as firewalls, endpoint security, network security appliances, and VPNs, which are increasingly important for customers as security breaches become more advanced and common. Keith points to the recent cyberattack on American Water Works, the largest water utility in the US, as an example of just how important effective cybersecurity solutions are.

KLA Corporation

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Ticker: KLAC

Market cap: $107.6 billion

Investment rationale: KLA provides process control technology, which is a key component in the semiconductor chip design process. The technology identifies defects in chips prior to production. For Keith, KLA is a picks-and-shovels opportunity to buy into the AI investment theme while avoiding the mega-cap stocks that other investors are piling into. The company's proprietary technology and pricing power allow it to innovate and stay ahead of competitors, Keith said. She also points to signs of good company management: KLA's employee turnover rates are much lower than other companies in the industry.

Guidewire

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Ticker: GWRE

Market cap: $15.4 billion

Investment rationale: Guidewire is the largest cloud-based software solution provider for the insurance industry. As more insurance providers migrate their operations to the cloud, Keith believes Guidewire is positioned to capitalize upon increased demand domestically and internationally. She points to Guidewire's well-established relationships with insurance carriers, recurring revenue streams, and brand reputation as signs of future growth.