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Where’s the Value Now? Mid-Cap Stocks Here’s Why…

Date: March 1, 2017      Publication: Bottom Line Personal      Source:  James Kieffer, CFA      Print:

Within weeks after Donald Trump was elected president, markets were hitting new highs and the bargain bin of stocks from which James ­Kieffer selects winners was looking very picked-over. The fund manager has had to dig deeper, relying on stock-picking skills honed over almost three decades as head of a “value” investing team. A good portion of the bargains he has been finding are among stocks of companies that are not too big and not too small—the so-called mid-cap stocks, whose market values range from $2 billion to about $20 billion. These stocks occupy a sweet spot relative to large-caps and small-caps. On average, mid-caps have higher potential returns than larger companies…and lower risk than smaller companies.

The good news, Kieffer says, is that despite the market’s gains, investors still can profit from buying stocks in the mid-cap realm—as long as they choose carefully and avoid companies that have climbed too far. Here are Kieffer’s rules for how to pick the best mid-cap stocks, and some of his current favorites…

Measure Risk vs. Reward

If you invest in stocks, it’s best not to shoot for the moon now. When the stock market has gone up the way it has in recent years, and especially post-election on speculation that President Trump’s policies might boost economic growth, it means that a lot of people aren’t being very careful and probably own shares of many overpriced companies. You can argue that it’s always ­important to be selective, but at times like this, smart stock picking can make a much bigger difference. When whole groups of stocks have climbed too far—utilities and real estate investment trusts are examples of sectors that clearly are overvalued now—there’s greater potential for a carefully selected portfolio to outperform the broad market.

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Here’s what to look for…

“Undemanding” valuations. A company’s profits and the amount of cash it produces must be high relative to the stock price. Sometimes, especially if a company is in an industry prone to booms and busts, you need to look at the history of its earnings. You can buy when profits are depressed—and the stock is likely a good deal—with some confidence about how much money it will make when things recover.

Strong finances. Look carefully at the balance sheet, and avoid any company that risks having its debt burden keep it from running its business well. That may seem obvious, but a lot of companies—and their investors—indulge in wishful thinking about how debt is going to get repaid or refinanced.

Skilled managers or strong market position. Even if a company is in a pretty mundane business, you should look for clear signs that the management has more industry expertise than its rivals—we like it when executives have long track records—or that the company has a dominant position in its business niche.

My 5 Favorite Mid-Cap Stocks

These five companies meet the criteria described previously and have strong prospects to outperform the overall market this year and beyond…

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AutoNation Inc. (AN) is the biggest franchiser of new-car dealerships in the US. These businesses generate a lot of cash—parts and service are particularly profitable…and financing as well as used-car sales also contribute. AutoNation has about 370 dealership franchises and has been perfecting its operations for some 20 years. Of course, auto sales go through ups and downs, affected by factors that are hard to predict, such as the price of oil and the state of the economy. In April, CEO Earl Hesterberg said automakers have been too slow to cut production amid indications that demand is softening, which may lead to excess new-car inventory and hurt prices. And AutoNation shares have traded below $50 recently, down from a peak above $65 in late 2015. But the decline in the stock is what makes the valuation attractive, so it’s a good time to buy. Recent share price: $52.62.

Goldcorp Inc. (GG) is a Canadian gold-mining company. Investors often look at gold producers as a proxy for owning the precious metal outright, since the miners have all that gold in the ground. But that’s not our reason for liking Goldcorp now. In fact, sometimes when gold goes up, miners’ stock prices go down. That happened during the decade when gold rose constantly (which ended in late 2011). There was too much easy capital available, and mining companies expanded recklessly. Today the industry is starved for capital, and Goldcorp is a survivor—well-run, with fewer strong competitors, and poised to deliver better profitability than the old Goldcorp. Recent share price: $15.79.

IAC/InterActiveCorp (IAC) is controlled by dealmaker Barry Diller. A collection of Internet companies, IAC is attractive if you make some cold calculations about the value of each individual business and then add it all up. The sum exceeds the current market capitalization by a good margin. The biggest piece is Match Group, made up of Match.com, OkCupid, Tinder and other popular dating services that dominate the online romance business. IAC completed a successful initial public offering of Match shares but still owns 83%. Other attractive parts of IAC include Vimeo, the online video service, and HomeAdvisor, which connects home owners with repair services. Recent share price: $68.93.

Kirby Corp. (KEX) is the biggest US operator of tank barges that move fuel, crude and petrochemicals along the rivers and coasts. As with any business in the energy or transport industries, Kirby goes through ups and downs, and this has been a down period. But management knows the routine—generate lots of cash during the good times…and snap up inexpensive assets during downturns. A stock like this is best purchased when profits have been hurting, and Kirby’s earnings this year are expected to be about half what they were at the peak in 2015. Recent share price: $65.30.

Liberty Ventures Group (LVNTA) is a mishmash of assets controlled by John Malone, who has spent decades building companies and doing deals in cable and telecommunications. In recent years, he has owned such assets as the shopping network QVC and a stake in the online travel business Expedia. To understand Liberty Ventures, you have to look into its complex web of cross-ownership. One important piece is a stake in Charter Communications, the second-biggest US cable-TV operator, which in January was reportedly talking with Verizon Communications about a possible merger. Liberty Ventures investors got that holding at a significant discount to the cost of buying Charter shares outright. So in the end, this is a bet on Malone—on the expectation that the 75-year-old dealmaker will be able to unlock value. Recent share price: $43.39.

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Source: James Kieffer, CFA, manager of the Artisan Mid Cap Value Fund (ARTQX), with $4.2 billion in assets. The fund returned an annualized 7.6% for the 10 years through January 31, 2017, compared with 7% for the Standard & Poor’s 500 stock index. ArtisanPartners.com