Mid cap stocks, measured by the Russell mid cap Index, generally outperform Large cap stocks, while adding only a slightly more risk and volatility as compared to small cap stocks. Mid cap stocks are usually in the prime of growth, tend to have low coverage of the Wall Street pundits and most times have larger growth potential than the large caps.
Compared to small-cap stocks which are perceived to be high risk and high reward investments, companies in the mid cap market capitalization range have been in the field for a longer time, have more established products and brand recognition, and a larger average trading volume.
Growth is a sweet spot in the mid cap market. Let us take advantage of this sweet spot by using the right criteria to pick the right stocks.
The Value Element
The debate of Value vs. Growth has been going on for years now, many believing that value stocks generally outperform growth stocks and many others remaining dedicated to the growth component for outperformance. In this article, I am looking to identify growing companies that have low valuation.
In order to add the Value element to this criteria, we have to look at the Price/Sales Ratio and PEG Ratio both less than or equal to 1. The Price/Sales ratio reflects how many times over investors are paying for each dollar of company's sales, and complements the Price/Earnings (P/E) ratio well. PEG Ratio helps finding companies that are trading at a discount to their projected growth - a value less than 1 hints that the stock trades at a discount to its growth. Lastly, consider stock with a low P/E estimate of less than or equal to 13 for the current year (the higher the P/E Ratio, the more the market is willing to pay for each dollar of annual earnings).
Growth - The Sweet Spot for mid caps
Some of the best and safer high growth stocks can be found in the mid cap space. To find high growth stocks, it is best to look at EPS trends over a period of time rather than at a specific time.
I consider EPS growth in the past year of more than 15%, which is well above the market median for mid cap stocks. If this EPS trend is better than the overall market, it is less likely that the company is having fundamental problems.
Apart from EPS growth, one should also look at positive revenue growth. Earnings can be manipulated by several accounting methods, so looking at a combination of positive earnings as well as revenue growth indicates that the business is doing well.
Icing on the cake - Analyst ratings
Another important aspect of finding the right stocks is Wall Street's perspective of the stock. Take serious note of what the analysts think about the company. For our purpose, let us narrow down further from our above list of criteria, to stocks with a Buy or better rating.
- US AIRWAYS GROUP INC (LCC)
Current Price: $12.24
EPS Growth for this year compared to last year: 298%.
Revenue Growth (TTM vs. Previous TTM): 8.45%
This year's P/E estimate is 4.5, PEG Ratio is 0.07.
Price/Sales ratio is 0.14.
- COOPER TIRE & RUBBER CO (CTB)
Sector/Industry: Consumer Discretionary/Auto Components
Current Price: $22.22
EPS Growth for this year compared to last year: 85.15%.
Revenue Growth (TTM vs. Previous TTM): 14.31%
This year's P/E estimate is 8.7, PEG Ratio is 0.61.
Price/Sales ratio is 0.33.
- ALASKA AIR GROUP INC. (ALK)
Current Price: $35.14
EPS Growth for this year compared to last year: 22.22%.
Revenue Growth (TTM vs. Previous TTM): 9.58%
This year's P/E estimate is 7.3, PEG Ratio is 0.58.
Price/Sales ratio is 0.55.
- URS CORP (URS)
Sector/Industry: Industrials/Construction & Engineering
Current Price: $37.38
EPS Growth for this year compared to last year: 17.14%.
Revenue Growth (TTM vs. Previous TTM): 5.50%
This year's P/E estimate is 9.0, PEG Ratio is (0.63).
Price/Sales ratio is 0.29.
The advantage of looking for value in mid cap companies that also have earnings and revenue growth, is that you are basically looking at possibly undervalued stocks that are young enough in their growth cycle to see the company grow substantially in size without the additional risk associated with small cap stocks.
The S&P 500 has continued to make new highs recently and bad economic news could reverse the trend any time, giving better entry opportunities to investors. Investors should consider broader market performance in recent times before deciding on initiating long positions, or add to their positions slowly for reduced risk exposure.