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11 hot stocks the market forgot
Midcaps are often overlooked by investors in favor of small or big caps. But they're providing some real muscle to the rally -- and giving no sign theyre fatigued yet.
By Jon D. Markman
Its not much of an exaggeration to suggest the stock market appears to be advancing with the strength of Hercules these days, since its the unlikely performance of medium-sized companies like Hercules Inc. (HPC, news, msgs) that is supplying the muscle.
Despite the celebrated January gain of small-cap stocks and the surprising performance of the big Dow Jones industrials, the best-performing market measure over the past six months has been the homely S&P MidCap 400/BARRA Value Index ($MUV.X). Its up 25% since last July 18, versus 15% for the S&P 500 ($INX) and Dow Jones Industrial Average ($INDU), and it hit historic highs in each of the past six weeks.
This is important because shares of medium-sized value companies -- ones that are $1 billion to $9 billion in market capitalization, with below-average price-to-earnings multiples -- are typically the most ignored on the board. And where there is ignorance there is opportunity. Not too big, not too small, not too flashy, not too overpriced, companies classified as midsized value often keep their beauty well-disguised behind a frightful mask.
The hidden charm of midcap value stocks is emblematic of the stealthy, tenacious bull-market advance of the past year. The advance has been sneaky because many investors have been fooled into thinking that the market, as embodied by the market-capitalization-weighted S&P 500 Index, has not yet hit new highs, the ultimate proof of bull status.
Yet the market is much more than the big bruisers of the S&P 500. If you look at an unweighted version of the index -- i.e., the S&P 500 Equal Weight Index ($SPXEW.X) or the Rydex S&P Equal Weight ETF (RSP) -- youll see that the average S&P 500 stock hit a lifetime high in August 2003 and has never looked back. Paul Desmond, head of the venerable Lowrys Reports technical analysis firm in Florida, said in an institutional report last week that this fact dispels the scenario that the current rally is nothing more than a cyclical rally within a secular bear market.
Former big caps
Who are these masked men? Although some are former small caps moving up in the world, most are former big caps, like Hercules, that have been kicked in the teeth, suffered long falls from grace and been rediscovered by bargain hunters. You can buy the whole lot of them as an exchange-traded fund with the iShares S&P MidCap 400/BARRA Value (IJJ). Or you can find interesting individual names in the bottom market-cap tier of the S&P 500.
Thats where Hercules, which has been doing its 12 mythic labors in obscurity, hangs out. Based in the industrial tidelands of coastal Delaware, the specialty chemical maker saw its shares sink to $6.50 from the mid-$60s over the past eight years. Weighed down by interest payments on expensive high-yield debt, the company almost went bankrupt in the late 1990s and only recently began to recover to $13 per share, thanks to efficiencies put in place by a new management team. The stock has ranked pretty high in our MSN StockScouter rankings, shooting as high as 10 before slipping back to 8 last week, because of its decent fundamental valuation and growth, some insider buying not far from the current price and nice but not flashy six-month price appreciation.
Considering the fact that its debt cant be refinanced until 2007 and asbestos-litigation costs lurk, Hercules shares probably arent going back to the $30s anytime real soon. But if the world economy continues to improve and the dollar remains weak, then heavy industrials like Hercules with sizable overseas sales can post impressive cash-flow and earnings gains. Analysts are expecting 15% to 30% income growth in the next year off a depressed base, but even earnings normalized at something like 10%-12% would make Hercules attractive after years of subpar performance and executive-suite missteps. If StockScouters forecast is correct, figure on an approach to $17 over the next 12 months -- a nice 30% move.
An easy way to find more midcap movers
There are many similarly compelling mid-cap industrials atop StockScouters Mid-Cap Value rankings these days, a list you can create yourself in the MSN Money Stock Screener (SS Rating >/= 8, SS Size = Mid, SS Style = Value). Click here for my version.
The best stocks at any time are ones that are moving up with their sector peers, so after running that screen, click on the Industry Name heading in the table and the stocks will be re-ranked alphabetically by industry. Then focus on the stocks in industries that have at least three or four representatives. Right now, the biggest mid-cap value industry clumps are Auto Parts, Diversified Utilities, Electric Utilities, Oil & Gas, Paper, Property & Casualty Insurance, Specialty Chemicals and Wireless Communications.
In the car-parts group, consider BorgWarner (BWA, news, msgs), which has risen 150% through hell and high water since January 2000, to clock in at a $2.5 billion market cap. Another company benefiting from the weaker dollar, it makes transmission, cooling and fluid systems for cars and trucks in 14 countries. BorgWarner recently provided positive EPS guidance for 2004 of $7.10 to $7.30. But with a weaker euro and a robust new-business pipeline, you can make the case that BorgWarner executives have smartly understated their earnings potential for next year. Deutsche Bank analyst Rod Lache, who has been around the block a few times, pegs fiscal 2004 EPS for BorgWarner at around $7.50, and he figures $9 for 2005. That translates into 15% to 20% earnings growth -- levels that could propel shares to the $120 area in the next 12 months from their current perch around $90.
In the wireless communications group, look at Western Wireless (WWCA, news, msgs). In the crazy days of the 1990s, Western Wireless traded into the mid-$70s at a price-to-sales multiple over 4, but in the more sober days of 2001, it traded around $35-$40 with a sales multiple of 2. Now fast-forward to today, when business has actually improved for the provider of wireless communications in rural Western United States communities under the Cellular One brand name, and its price-to-sales multiple is down to 1.30. Not to argue that sales multiples are the right way to value a wireless carrier, but it makes for an easy apples-to-apples comparison.
The company has by all accounts done a good job of adding subscribers in the past quarter, and considering that analysts have undershot their earnings estimates the past couple of quarters, there is room for another surprise and boost in estimates after the company reports its winter quarter in early February. The companys free cash flow is improving, and there is talk of either a sale or spin-off of its international properties in places as far-flung as Austria, Slovenia, Ghana and Bolivia later this year. Western Wireless shares are up 62% in the past six months, but if StockScouters rating is right, it could reach the $32 area from its current level around $23.50 in the next six to 12 months.
Dont ignore the potential
Desmond, the Lowrys Reports analyst, said that a great many professional money managers have fought the current uptrend in mid-cap and small-cap stocks, either by short-selling or keeping a lot of cash on hand to utilize after an expected crash to bear-market lows. These managers have dramatically underperformed the market, he notes, and if they are ultimately forced to both cover their shorts and buy stocks like BorgWarner and Western Wireless, he forecasts a continued advance for at least the next nine months.
In this scenario, another Herculean move of the broad market of 20%-25% this year should not be considered merely a mythic fantasy, but a real possibility. Here are 11 midcap value stocks that could make it happen.
| StockScouter's high-rated midcap value stocks for 2004's first half | | Company | Rating | 1/19 price | Industry | | The Phoenix Cos. (PNX, news, msgs) | 9 | $12.69 | Property & casualty insurance | | Perrigo (PRGO, news, msgs) | 10 | $17.00 | Drug-related products | | Hercules (HPC, news, msgs) | 8 | $12.85 | Synthetics | | Huntington Bancshares (HBAN, news, msgs) | 8 | $22.59 | Regional - Midwest banks | | The Pep Boys - Manny Moe & Jack (PBY, news, msgs) | 7 | $23.61 | Auto parts stores | | Western Wireless (WWCA, news, msgs) | 10 | $23.65 | Wireless communications | | Alliant Energy (LNT, news, msgs) | 9 | $24.95 | Diversified utilities | | American Financial Group (AFG, news, msgs) | 8 | $27.55 | Property & casualty insurance | | RadioShack (RSH, news, msgs) | 10 | $32.75 | Electronics stores | | W.R. Berkley (BER, news, msgs) | 9 | $37.85 | Property & casualty insurance | | BorgWarner (BWA, news, msgs) | 9 | $93.96 | Auto parts |
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Fine Print
The fastest and easiest way to screen for midcap stocks that our StockScouter system likes is to visit this single page. To find some of the systems favorite value stocks, click here. . . . To learn more about Hercules, click here. . . . To learn more about Western Wireless, click here. . . . To learn more about BorgWarner, click here.
Jon D. Markman is publisher of StockTactics Advisor, an independent weekly investment newsletter, as well as senior strategist and portfolio manager at Pinnacle Investment Advisors. While he cannot provide personalized investment advice or recommendations, he welcomes column critiques and comments at jdm@oddpost.com. At the time of publication, Markman owned or controlled accounts with positions in the following securities mentioned in this column: Perrigo, Hercules, Western Wireless, BorgWarner.
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