3 Undiscovered Mid-Caps Ready To Run

Mid-cap companies — those valued between $2 billion and $10 billion — have underperformed both their larger and smaller peers this year. The iShares Russell Mid-Cap ETF (NYSE: IWR) has increased just 6.9% so far this year versus a performance of just over 9% for both the large- and small-cap indices.

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That contrasts with a longer-term track record of outperformance for these companies “caught in the middle” and some good reasons the group could return to dominate market returns.

They may not be as exciting as small caps or get the media coverage of large caps, but this group of up-and-comers consistently surprise investors.

#-ad_banner-#Mid-caps offer a rare mix of growth and safety you won’t want to miss.

There’s Nothing Middle-Of-The-Road About Mid-Cap Potential
The underperformance in mid-cap stocks this year contradicts a strong track record against the small- and large-cap groups. Mid-caps outperformed the other two groups by more than 50% over the seven years to 2016.

Going further back, data since 1997 shows mid-caps have outperformed large-cap stocks 64% of the months when the S&P 500 posted a positive return and 51% of the time against small-caps. What’s more, they do it with relatively less risk versus the other two groups.

Data from FactSet Research over the two decades through October 2017 shows that mid-cap stocks have a higher Sharpe Ratio compared to the two groups. That measure of the return tradeoff, calculated by annualized return divided by risk, is 0.50 for mid-cap stocks and just 0.41 for small-caps and 0.36 for stocks in the S&P 500.

Why have mid-caps historically bested smaller- and larger companies… and can they do it again?

Mostly focused on domestic sales, mid-caps should be less affected by the evolving trade war compared to their larger, international peers. The relative insulation to geopolitical issues has shielded the group any time global growth becomes a problem.

With the U.S. leading the way in developed market growth, mid-caps should have no problem growing sales.

Their advantage over large cap peers is rounded out with a greater operational flexibility and focus on a smaller business model. Mid-caps can concentrate on a single region or product-line rather than scale the business into enormity.

Perhaps the greatest advantage the group has for returns is as takeover targets and from activist investors. Once a company reaches $2+ billion, it’s generally developed through the risk of a fledgling business. It’s created brand loyalty, distribution and production economies that are hard to find in smaller companies.

Even at $10 billion in market cap, these companies are still relatively easily acquired by their S&P 500 peers and a controlling position can be purchased with a small investment.

Mid-caps may represent the best opportunity for safety and growth over the next several years. They have the financial flexibility to survive a recession but also the faster potential growth that comes with smaller companies.

In that data going back to 1997 on monthly returns, mid-caps outperformed small-caps 57% of the time the S&P 500 posted a monthly loss. While mid-caps generally lagged their larger rivals, they still outperformed large-caps 46% of the time the broader market posted a monthly loss.

Three Mid-Caps To Put On Your Radar
There are 957 U.S.-based companies trading on the exchanges with a market cap of between $2 billion and $10 billion. To narrow the list to potential targets, I looked for companies with limited analyst coverage and held by fewer than 10 institutional funds.

Looking further for companies with catalysts for growth, that means when the rest of the market catches on to these mid-cap money machines, these companies could take off.

Bio-Rad Laboratories (NYSE: BIO) is an $8.9 billion manufacturer and supplier of chemicals and biological materials to the healthcare sector. Despite its mid-cap size, the company generates 80% of its sales from products in which it has a leading market position.

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The company’s recent expansion into the U.S. blood-typing market is driving management’s conservative estimate for 4% organic sales growth this year. New product areas such as droplet digital PCR and cell biology could drive sales considerably higher over the next several years.

Bio-Rad is cash rich with $761 million in balance sheet cash against just $435 million in long-term debt. Shares trade for 70.6-times trailing earnings but much more reasonably when you consider analyst estimates are for earnings to surge 63% over the next four quarters.

Moog Inc (NYSE: MOG-A) is a $3.0 billion diversified industrial supplier in aircraft controls (43% of 2018 sales), space and defense controls (22%), and industrial systems (35%). The company books nearly a third (31%) of revenue from military and government-funded contracts with 58% of total sales from within the United States.

The company has benefited from the increase in military systems spending with full year sales in the space and defense segment expected higher by 9% versus 2017. A recent reorganization within the segments could drive customer engagement and improve operational performance.

The shares trade for 19.5 times trailing earnings which are expected higher by 15.5% over the next four quarters.

Watsco Inc (NYSE: WSO) is a $6.6 billion distributor of HVAC units serving more than 40,000 contractors and dealers in 38 states. The company’s $4.4 billion in annual sales dwarfs its next largest competitor in the space with just $1.5 billion in sales, giving Watsco a commanding lead in the market.

The company’s relative size versus competitors is enabling it to spend on technology and drive a digital transformation in the market that could see it further grab share. Watsco has improved its service level fill rates by 300 basis points to 97% and retention among ecommerce users is 2.5-times higher than traditional users.

Watsco is a rare dividend story among mid-cap stocks, paying a 3.24% annual yield. Shares trade for 27.9 times trailing earnings which are expected 11.6% higher over the next four quarters.

Risks To Consider: Smaller companies tend to get hit the hardest during economic downturns though these mid-caps should have the financial flexibility to survive.

Action To Take: Position ahead of the market in these undiscovered mid-cap companies with catalysts for growth.