Mid-cap value stocks deserve some TLC
Just like poor Jan Brady, they are getting a lot less attention than their larger and smaller siblings.
If you're a fan of the classic 1970s TV show "The Brady Bunch," you know well the plight of Jan. While older sister Marcia was the pretty, do-no-wrong girl-next-door, and younger sister Cindy was a ball of lisping, curly-haired cuteness, Jan was awkward, angst-ridden, and often overlooked as the Bradys' middle daughter. (You may remember her famously complaining that all anyone ever talked about was, "Marcia, Marcia, Marcia!")
Well, in the stock market right now, a bit of a Brady-Bunch-girls dynamic is occurring among value stocks. According to Morningstar's total return style-box indices, small-cap value stocks are currently trading for about 13.6 times prospective earnings, and their large-cap peers are trading for 12 times prospective earnings. Mid-caps, meanwhile -- the Jan Bradys of the market -- are getting little attention, trading at a just over 10 times prospective earnings.
The bargain-basement prices of mid-caps are perhaps a result of investors' highly bifurcated outlook for the stock market. For the past few years, in fact, it's been hard to find someone who has a relatively neutral view of stocks. Instead, many are highly bearish, fearing another recession or financial crisis, while many others are highly bullish, feeling that valuations and the wall of liquidity supplied by central banks around the world have made stocks screaming buys. Logic would reason that the bears would key more on larger stocks, which are typically considered safer, while the bulls would focus on smaller stocks, which tend to be more volatile and lead the market during upswings.
Whatever the reason, many mid-cap value stocks are looking quite attractive right now. I recently used my Guru Strategies, each of which is based on the approach of a different investing great, to find some of the most fundamentally sound, attractively valued mid-caps in the market. Here are a handful that caught my eye. As always, you should invest in stocks like these within the context of a broader, diversified portfolio.
Lear Corporation (LEA): Michigan-based Lear supplies automotive seating and electrical power management systems. The $5.6-billion-market-cap firm has employees in 36 countries, and in the past year has taken in nearly $15 billion in sales.
Lear gets strong interest from three of my strategies. My Peter Lynch-based model likes its 24% long-term earnings per share growth rate and 4.8 trailing 12-month (TTM) P/E ratio, which make for a stellar 0.2 P/E-to-Growth ratio. (Lynch developed the PEG as a way to gauge value.) Even if we use Lear's projected earnings for the coming 12 months, which makes for a much higher P/E, the stock still trades at a PEG of less than 0.5. This model considers anything under 1.0 a good value, and anything under 0.5 the best case.
My James O'Shaughnessy-based growth model also likes Lear, thanks to its history of increasing annual EPS in each year of the past decade, and its combination of a strong 80 relative strength and low 0.38 price/sales ratio. That shows that, while the stock is being embraced by the market, it hasn't gotten too pricey. And my Kenneth Fisher-inspired strategy likes that low price/sales ratio, the company's reasonable 31.5% debt/equity ratio, and its $2.17 in free cash per share.
Gannett Co., Inc. (GCI): It's been a rough period for newspaper and media companies, and Gannett is no exception, having just had another round of layoffs earlier this year. But my Joel Greenblatt-inspired strategy thinks the S4.9-billion-market-cap firm's shares have gotten much too cheap. Greenblatt's strategy is a remarkably simple one, looking at just two variables: earnings yield and return on capital. Gannett has a bargain-priced earnings yield of 14.7%, and a whopping 657% return on capital. Those two figures combine to make it the third most attractive stock in the U.S. market, according to this strategy.
Alliant Techsystems Inc. (ATK): Virginia-based Alliant ($2.5 billion market cap) is in the aerospace, defense, and commercial products arenas, with offerings that range from ammunition to rocket motors to aircraft components. The model I base on the writings of Benjamin Graham -- the man known as "The Father of Value Investing" -- is high on the stock. The conservative strategy likes Alliant's 2.45 current ratio and $1.3 billion in net current assets vs. $1.0 billion in long-term debt. It also likes the price: Alliant trades for 9.3 times TTM earnings and 1.7 times book value.
Western Refining, Inc. (WNR): Shares of this Texas-based oil refiner ($2.6 billion market cap), which also operates service stations and convenience stores, were already cheap when news of potential new gas standards hits refiners hard in late March. Now they are dirt cheap, trading for less than six times TTM earnings and 0.28 times TTM sales. Its P/E ratio and 24% long-term growth rate make for a PEG ratio of just 0.24, part of the reason my Lynch-based model likes the stock. My Greenblatt-based model, meanwhile likes its 40.5% earnings yield and 65.5% return on capital. It considers the stock the seventh best in the market right now.
Joy Global, Inc. (JOY): Shares of this Milwaukee-based mining equipment provider ($5.8 billion market cap) have struggled for much of 2013 as fears of a Chinese slowdown and the U.S.'s sluggish economy kept investors away. But my Greenblatt-inspired model thinks the stock is a bargain. It likes Joy's 17% earnings yield and 47.3% ROC, which combine to make the stock the 28th best in the entire U.S. market right now, according to this approach.
Joy also gets high marks from my Lynch-based model, thanks to its 20.4% long-term growth rate and 7.6 P/E, which make for a stellar 0.38 PEG.
I'm long LEA, GCI, ATK, and WNR.
John Reese is the founder and CEO of Validea Capital Management and Validea.com and the author of The Guru Investor: How to Beat the Market Using History's Best Investment Strategies.
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