4 Promising Mid Caps Largely Being Ignored by the Market

Includes: CHRW, EMS, SJM, VAR
by: John P. Reese

To most investors, the name Thyra Zerhusen probably doesn’t ring any bells.

It should.

While she doesn’t get nearly the attention that some other star fund managers get, Zerhusen has quietly compiled an impeccable track record while heading the Aston/Optimum Mid-Cap Equity fund since 1994. The fund has averaged returns of 8.37% over the past ten years and 11.14% over the past 15 years, figures that blow away the broader market and put the fund in the top 5% and 2% of its class over those respective periods, according to Morningstar.

Just as she herself gets overlooked in the investment world, Zerhusen's strategy targets the types of stocks that are often overlooked by other investors. In a recent interview with SmartMoney magazine, she said she keys on medium-sized companies with market capitalizations between $1 billion and $12 billion. While many investors key on small-cap upstarts or big blue chips, such mid-sized firms, she said, are “largely ignored”.

Like Zerhusen, several of my Guru Strategies (each of which is based on the approach of a different investing great) key on stocks that are being overlooked by investors for one reason or another. While some target small-caps and others target very large stocks, none of my models specifically key on mid-cap stocks (though many don't limit their picks by size). Because of that I thought it would be interesting to see which mid-cap plays my models are keen on right now. I found a number that fit the bill. Here's a look at some of the best of the bunch.

Emergency Medical Services Corporation (NYSE:EMS): This medical services firm operates ambulance services in 38 states and the District of Columbia, and also provides emergency department and facility-based physician services. The Greenwood Village, Colo.-based company's services also include paramedic and EMT training, physician education and training, and disaster response.

EMS ($2.3 billion market cap) is a favorite of my Peter Lynch-based strategy. SmartMoney reported that one way Zerhusen finds bargains is by comparing a firm's price/earnings ratio to its growth rate, and the P/E/Growth ratio -- pioneered by Lynch -- is a key part of my Lynch-based method. When we divide the firm's 19.7 P/E by its 44.8% long-term growth rate (using an average of the three- and four-year earnings per share growth rates), we get a P/E/G of 0.44. That falls into my Lynch-based model's best-case category (below 0.5). While you shouldn't expect the firm to continue growing earnings at such a high rate over the long haul, its P/E/G is low enough that it still appears to be a good buy at this price.

EMS also appears to have manageable debt, with a 55.9% debt/equity ratio, another reason my Lynch model likes it.

The J.M. Smucker Company (NYSE:SJM): Known for its jellies and jams, this $7.3 billion-market-cap firm's major products also include coffee, peanut butter, shortening and oils, canned milk and baking mixes. The Orrville, Ohio-based company is another favorite of my Lynch-based model, which considers it a "stalwart" because of its moderate 13.8% long-term growth rate (based on an average of the three-, four-, and five-year EPS growth rates) and multi-billion-dollar annual sales ($4.6 billion).

For stalwarts, Lynch adjusted the "G" portion of the P/E/G to include dividend yield. Thanks in part to its 2.6% yield, Smucker's has a yield-adjusted 0.89 P/E/G, which comes in under the model's 1.0 upper limit -- a sign that it's a bargain. The firm also has a solid 24.3% debt/equity ratio.

Varian Medical Systems, Inc. (NYSE:VAR): Based in Palo Alto, Calif., Varian ($7.2 billion market cap) makes technologies that treat cancer and other conditions using radiotherapy, radiosurgery, proton therapy, and brachytherapy. It also makes X-Ray imaging tools used in medical and scientific fields, as well as for screening cargo and industrial inspections.

Varian is a favorite of my Warren Buffett-based strategy. This model looks for firms with lengthy histories of earnings growth, manageable debt, and high returns on equity (which is a sign of the "durable competitive advantage" Buffett is known to seek). Varian delivers on all fronts. Its earnings per share have increased in every year of the past decade; it has more than 20 times as much annual earnings ($360 million) as debt ($17.9 million); and its 10-year average ROE is an impressive 24.4%.

C.H. Robinson Worldwide (NASDAQ:CHRW): This Eden Prairie, Minn.-based transportation and logistics firm has a market cap of about $11.4 billion, and has raked in about $8.5 billion in sales in the past year. It has an excellent history of growing earnings, having done so in each year of the past decade. That's part of why it gets high marks from my Buffett-based model. A couple more reasons: The firm has no long-term debt, and it has averaged a 25.9% return on equity over the past ten years.

Robinson also gets approval from my James O'Shaughnessy-based growth model, which targets firms that have upped EPS in each year of the past five-year period. O'Shaughnessy used a key tandem of variables when looking for growth stocks: A high relative strength (which is a sign the stock is being embraced by Wall Street), and a low price/sales ratio (a sign it hasn't gotten too pricey). With a solid RS of 70 and a P/S ratio of 1.34, Robinson makes the grade.

Disclosure: I'm long SJM.