The Best In Light-Blue Chips

10/24/2011


Investors like the concept of blue-chip stocks, quality companies capable of putting up solid growth without undue risk.

At the moment, the Forecasts favors a lot of traditional large-capitalization blue chips, a group that seems attractively valued relative to its growth potential. But what if you look a little bit further down the food chain, focusing on companies large enough to hold important positions in their markets, yet small enough to be buoyed by waves of growth that can't lift larger companies? Call these companies "light-blue chips."

Historically, small stocks have averaged higher returns than large stocks. Midcaps split the difference, generally delivering returns superior to those of larger companies, without as much volatility as the smallest stocks. Midcap stocks averaged 12.2% annual returns in rolling periods from the start of 1992 through August 2011. Midcaps' returns were comparable to those of small-cap stocks, but with lower volatility, as measured by standard deviation.

In a study of annual returns from 1926 through 2010, Morningstar found that midcaps averaged 13.9% returns, well above the 11.9% return for larger stocks. Small-caps delivered even higher returns, but at the cost of greater volatility, and midcaps outperformed on a risk-adjusted basis.

The Forecasts' study also considered median returns — which are less affected by the relatively small number of extremely high returns that drive up the average for small-caps and microcaps. Based on median returns, midcaps look even better.

Over the last five years in particular, midcaps have truly stood out from the pack, delivering higher average 12-month returns than large-caps or small-caps and higher median returns than any of the three other market-capitalization groups.

So what is a midcap, anyway? For the purpose of this analysis, we started by dividing New York Stock Exchange stocks into deciles based on stock-market value. Then we slotted the rest of our research universe of nearly 5,000 U.S.-traded stocks into those deciles, based on their market value. The first two deciles (tenths) are large-cap stocks. Deciles three through five contain midcaps. Most companies are small, so the last five deciles (small-caps and microcaps) contain many more stocks than the first five. The boundaries of those deciles have changed over time. At the moment, any stock with a market value between $2.01 billion and $9.21 billion qualifies as a midcap.

MARKET-CAP ANALYSIS
Midcap stocks compare favorably to small-cap stocks in several ways. Midcaps average higher Quadrix Overall scores and stronger profit and cash-flow growth over the last year. Midcaps include stocks that fall within deciles three through five of the New York Stock Exchange as measured by market capitalization.
Large-Cap
(Deciles 1-2)
Midcap
(Deciles 3-5)
Small-Cap
(Deciles 6-8)
Microcap
(Deciles 9-10)
No. of stocks
482
771
1,075
2,093
Largest mkt. value (mil. of $)
379,010
9,208
2,006
505
Smallest mkt. value (mil. of $)
9,233
2,013
505
11
Total market value (mil. of $)
17,060,958
3,344,773
1,269,548
385,385
Avg. market value (mil. of $)
36,070
4,668
1,153
182
Average Quadrix score
Overall
68
57
52
43
Momentum
59
55
52
45
Value
60
51
50
48
Quality
67
62
54
40
Financial Strength
62
56
52
44
Earnings Estimates
48
46
46
54
Performance
60
56
52
44
Average valuation
Price/earnings ratio
15.7
18.3
18.1
17.3
Price/earnings vs. 5-yr. med.
0.88
0.96
0.94
0.97
Price/sales ratio
2.2
2.4
2.2
1.7
Price/sales vs. 5-year median
0.95
1.03
0.99
0.89
Price/operating cash flow ratio
10.8
11.7
11.2
9.8
Price/cash flow vs. 5-yr. med.
1.04
1.04
1.23
1.4
Average trailing 12-mo. growth
Sales (%)
16
16
16
10
EPS (%)
18
17
12
4
Operating cash flow (%)
7
5
0
(9)
Avg. trailing 5-yr. annual. growth
Sales (%)
10
10
10
9
EPS (%)
8
7
4
(1)
Operating cash flow (%)
9
8
7
1
Average estimated EPS Growth
Current year (%)
16
15
10
2
Next year (%)
14
18
20
23
Next 5 years (annualized) (%)
15
14
15
17
Average total return
3 months (%)
(9)
(13)
(15)
(20)
6 months (%)
(8)
(11)
(14)
(20)
12 months (%)
5
7
2
(8)
3 years (annualized) (%)
16
18
12
0
Note: Averages exclude P/E ratios below 0 or above 75, P/S ratios below 0 or above 15, P/CF ratios below 0 or above 35, 12-month and future growth rates or returns above 100%, and annualized growth rates or returns above 50%.

The table below lists 10 attractive midcaps, some recommended by our sister publication Upside, which focuses on smaller stocks. Four midcaps are detailed below.

Advance Auto Parts ($62; AAP) has steered clear of the economy's potholes, cruising to 11 straight quarters of higher same-store sales. In the past five years, Advance Auto has delivered annualized growth of 15% for per-share earnings and 10% for operating cash flow.

Shares have risen 12% since the end of July, while the S&P 500 Index sagged 6%. Advance Auto also looks good relative to its peers, as shown by sector-specific Quadrix scores (12-Factor Sector and Reranked Overall) of at least 85.

Gasoline prices have jumped 22% from last year, dragging down U.S. demand and miles driven. But two other trends tilt in Advance Auto's favor: Americans are driving older cars, and consolidation by U.S. automakers during the recession has left fewer dealerships, broadening the market for independent garages that install generic parts sold by Advance Auto. Advance Auto is a Long-Term Buy.


Alliance Data Systems' ($94; ADS) direct-marketing services, customer-loyalty programs, and private-label credit cards help clients reach target audiences that keep fracturing into smaller groups. In the past five weeks, Alliance has won contracts with Marathon Petroleum ($36; MPC) and Pier One ($11; PIR) to provide credit-card services.

For the September quarter, Alliance's private-label segment reported average receivables down 1%, while net charge-offs equaled 6% of revenue. In the year-earlier quarter, net charge-offs topped 8%. As of Sept. 30, the delinquency rate had fallen to 4.9% from 6.1% a year ago.

Alliance was slated to announce its full results Oct. 20, after the Forecasts' publishing deadline. Wall Street expects the company to report earnings of $1.89 per share, up 22%, on revenue of $797 million, up 14%. The company is expected to grow per-share earnings 14% in 2012. Alliance is a Focus List Buy.


With a market value of $3.82 billion, AGCO ($39; AGCO) is the smallest stock on the Forecasts' Buy Lists. Shares dipped after rival Deere ($70; DE) lowered its U.S. outlook for combines in the coming year due to concerns about a large supply of used equipment. Farmers, encouraged by robust crop prices in recent years, have spent heavily on machinery. Combines accounted for 6% of AGCO's revenue last year.

AGCO derives about half of its revenue from Europe, the Middle East and Africa, and uncertainty over Europe's financial situation adds some risk to the stock. Still, the world's food needs require a $90 billion investment in agriculture each year, says an industry-sponsored report.

For the September quarter, AGCO is expected to report per-share earnings of $0.75, up 14%, on 22% rev-enue growth. Analyst estimates have risen in the past month, and the company has exceeded the consensus by more than 15% in each of the last four quarters. Scheduled to post quarterly results Oct. 25, AGCO is a Buy.


BMC Software ($39; BMC) products help run data centers, the sleek and sterile rooms that house computers that operate businesses. BMC's business is partly sheltered from downturns because its software automates computer processes and keep clients' operating costs low. In August, management said customers were re-examining large orders rather than canceling them. BMC, due to report Oct. 26, is expected to post a 1% profit decline for the September quarter. But projections for fiscal 2012 ending March call for 10% growth.

Prior to this year, BMC's trailing P/E hadn't fallen below 16 since 1995. At 12 times trailing earnings, the stock trades 37% below its three-year average and 9% below its peer-group median. BMC Software is a Buy and a Long-Term Buy.

TOP MIDCAP PICKS
Below are 10 midcap selections. Stocks followed by our sister publication Upside, which focuses on small and midcap stocks, are listed in green. We categorize as midcaps companies with market capitalizations within the range defined by deciles three through five of New York Stock Exchange stocks. At the moment, the largest stock in decile 3 has a market value of $9.21 billion, while the smallest in decile 5 has a market value of $2.01 billion.
P/E Ratio
12-Month
Growth
Est. EPS
Growth
Quadrix Scores
Company (Price; Ticker)
Stock-
Market
Value
($Bil.)
Trailing
Vs.
5-Yr.
Median
Sales
(%)
EPS
(%)
Oper.
Cash
Flow
(%)
Curr.
Year
(%)
Next
Year
(%)
Value
Quality
Overall
Industry
Advance Auto Parts
($62; AAP)
4.8
14
0.88
7
31
(16)
19
13
70
87
92
Specialty Retail
AGCO ($39; AGCO)
3.8
10
0.49
27
NC
(17)
77
8
92
81
98
Machinery
Alliance Data Systems
($94; ADS)
5.5
14
0.67
25
39
46
23
14
50
90
85
IT Services
BMC Software
($39; BMC)
7.0
12
0.59
10
15
33
10
9
78
93
94
Software
CVR Energy
($27; CVI)
2.4
11
NA
32
NA
NC
878
4
86
89
100
Oil, Gas & Cons. Fuels
HealthSpring
($40; HS)
2.7
11
1.09
53
28
64
19
5
66
94
97
Health Care Providers
Neustar ($31; NSR)
2.3
17
1.02
13
20
NA
25
18
44
91
95
IT Services
Pan American Silver
($28; PAAS)
3.1
16
NA
40
NC
70
93
50
82
99
99
Metals & Mining
RPC ($19; RES)
2.7
11
0.78
94
NC
NC
115
25
76
99
98
Energy Equipment
Walter Energy
($75; WLT)
4.7
9
0.55
65
94
33
4
25
92
99
85
Metals & Mining
Note: Quadrix scores are percentile ranks, with 100 the best.    NA Not Available.    NC Not Calculable.

 


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