Panera Bread had a proven recipe for restaurant expansion and profits, and for years the markets ate it up. But in 2016 it seemed as if some investors were losing their appetite. Even with brisk sales and rising profitability from new in-store enhancements, Panera shares trailed a benchmark of small- and medium-size growth companies for much of the year.

The company’s otherwise solid execution came at a time of broader market indigestion toward dining businesses and shifting consumer buying trends. Yet that didn’t deter European holding company JAB from announcing in April 2017 that it would acquire Panera for $7.5 billion, a premium of more than 50% to the share price at the end of the previous year.

For Panera shareholders, the deal was a windfall that highlighted the advantages of a unique blend of small-cap and mid-cap equities. Known as SMID-cap stocks, the asset class bridges between companies with smaller market capitalizations and stocks at the lower end of the mid-cap valuation range like Panera.

The SMID Sweet Spot

SMID-cap investing has attracted growing interest from investors because it targets a compelling sweet spot of risk-adjusted return. It’s based on the high risk, high reward aspects of small-cap stock investing while blending in seasoned medium-sized companies that partially offset the challenges and volatility experienced by their smaller peers. Panera was an example of mid-cap company with a long resume of earnings growth and seasoned management that was not fully appreciated by the market—and ultimately delivered rewards to investors.

Smaller companies have outperformed large-cap stocks for decades (Display). But small-cap stocks are usually more volatile, suffer from thin trading liquidity and are often more vulnerable to business downturns or macroeconomic slowdowns.

In this paper, we demonstrate the benefits of adding a layer of medium-sized companies like Panera to a portfolio of smaller stocks. With better business plans and stronger balance sheets, smaller mid-caps are generally much more profitable than small-caps (Display).

Powerful Potential In SMID Stories

Through stories of individual companies, we illustrate the opportunities and risks, and highlight the importance of applying a bottom-up, active approach, to SMID-cap investing. In our view, this approach can help investors identify SMID companies that are better equipped to weather unforeseen shocks to the economy or markets, while providing added maturity, tested business models and higher financial resiliency.

In a world of lower expected returns and heightened uncertainty, we believe that SMID-cap stocks are an important component of an equity allocation that can help investors enjoy the high-return potential of small-cap investing while taking the edge off the accompanying risk.