By Serkan Unal
Mid-cap stocks with attractive dividend yields or consistent dividend growth, or a combination of both, that are less expensive than the market and growing steadily represent good investments in any market environment. Mid-cap value stocks have shown to outperform the broad market over specific time horizons. For example, over the past 10 years, the Russell Midcap Value Index beat the broader-market benchmark, the Russell 3000 Index, by a differential of nearly 3 percentage points. Year-to-date, that differential is about 2 percentage points.
We looked for the best mid-cap value stocks in the Dreman Mid Cap Value Fund, which is managed by the renowned contrarian investor David Dreman, who boasts 53 years of investing experience. The fund consists of 69 securities of companies "in the prime growth phase of their business cycle" that are priced below the market or their respective industries. We scanned the fund's non-financial holdings with market capitalization between $2 and $10 billion and picked five stocks with yields above 2%, focusing on those that have the largest shares in the fund's net assets. Here is a closer look at the selected five stocks.
Cardinal Health (CAH), a drug and medical supplies wholesaler, pays a yield of 2.6% on a payout ratio of 35%. Its dividends grew, on average, by 16.6% annually over the past five years. Analysts forecast the company's 5-year EPS CAGR at close to 10%, a slight acceleration compared to average annual growth over the past five years. The steady pharmaceutical demand and its oligopolistic market position in the drug distribution market bode well for the company's sustained profitability and strong cash flows. The ratings house Fitch Ratings recently concluded that "the amount of cash returned to CAH shareholders will likely continue to grow," given the company's ample liquidity. The stock has a miniscule price-to-sales of only 0.1, and is priced below its peer group based on a price-to-book ratio. It is valued at 13.1x its trailing earnings and 11.1x its forward earnings. The stock has a free cash flow yield of 4.9% and ROE of 18.4%. Viking Global's Andreas Halvorsen owns more than $200 million in this stock.
Huntsman Corporation (HUN), an inorganic and organic chemicals maker, yields 2.5% on a payout ratio of only 19%. This cash-rich company has a free cash flow yield of 11.2%. Its dividend has been flat since 2007, and it was maintained constant even during the down years. The company's long-term EPS growth is forecasted at 7.4%, reversing the trend of negative growth, on average, over the past five years. Huntsman beat on EPS growth in the latest quarter, even though it missed on revenues. The company has seen some pricing power return and is expanding a plant producing foam insulation compounds to meet the rising demand. Huntsman shares are trading at below-industry price-to-book of 1.8 and price-to-sales of only 0.3. It is good value given its forward P/E of 6.1x and a PEG of only 0.4. The stock has a ROE of 26%. It is popular with fund managers John Burbank and David Tepper, both of whom raised their stakes in the chemicals maker in the previous quarter.
Marathon Oil Corporation (MRO), an energy company, has a dividend yield of 2.2% and a payout ratio of 27%. Marathon Oil increased its dividend in 2012 by 13.3%, although the quarterly dividend remains below levels in some of the previous years. The company's long-term EPS growth is forecasted at about 6.0%, based on increased oil production from the rich oil shale play Eagle Ford. The company has beaten and raised targets and is transforming into a growth story. These factors should lead it toward a higher multiple. The energy company is trading at a 20% discount to its industry based on a price-to-book ratio of 1.2. It is priced at 12.2x trailing earnings and 9.4x forward earnings. It is good value given its PEG of 0.8. In the previous quarter, billionaire Steven Cohen boosted his stake in the company by nearly 200%.
Crane Co. (CR) produces engineered industrial products, airplane componentsm and fluid handling valves. Its dividend is yielding 2.4% on a payout ratio of 142% of trailing earnings and 58% of free cash flow. Over the past five years, the company's dividends grew, on average, by 10.4% annually. Analysts forecast the company's long-term EPS growth at 8.5%. Crane has just agreed to acquire MEI Conlux Holdings, an unattended payment solutions company, for $820 million. The deal, funded by a combination of cash and debt, will improve Crane's standing in payment solutions and will be accretive to EPS expansion and general growth prospects. Crane's shares are trading 10.6x its forward earnings. Its price-to-sales of 1 is 40% lower than the industry average. Value investor Chuck Royce is a buyer of this stock.
Energizer Holdings Inc. (ENR), the battery and razor maker, pays a dividend yield of 2.0% on a payout ratio of 26%. The company started paying a dividend in the third quarter of 2012. This cash-rich company has a free cash flow yield of 10.5% and generates consistently strong cash flows, which suggests it may be likely to grow its dividend in the future. Analysts forecast the company's long-term EPS growth at 10.6%, much faster than over the past five years. The company has just released its preliminary EPS forecast for 2013, which surpassed analyst expectations. This expected growth will be driven by the battery maker's diversified product mix, innovative new products introduction, and the ongoing restructuring efforts. The stock has a below-industry price-to-book, price-to-sales, and price-to-cash flow ratios. It is cheaper than its peer group on a forward basis, with a forward P/E of 12.1x versus the industry's 16.9x. Fund manager Alexander Roepers (Atlantic Investment Management) held nearly $190 million in the stock at the end of September.