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By Aaron Levitt
| February 14, 2017
Goldilocks had it right: The middle is truly the sweet spot. That holds especially true for investors, as mid-cap stocks offer the best of two worlds.
Mid-caps are typically defined as companies between $2 billion and $10 billion in market capitalization, though certain definitions include bigger market caps.
They feature many of the qualities of small caps, such as the potential for growth; the idea is that it’s a lot easier to double earnings of $10 million than it is to double earnings of $10 billion. However, they have easier access to credit and typically boast more diverse revenue streams — advantages that large-caps often have, but small-cap stocks typically lack.
Most importantly, mid-cap stocks perform.
Mid-caps — as represented by the SPDR S&P MidCap 400 ETF (MDY) — have returned 12.22% annually since the ETF’s inception in the mid-1990s. That beats both the large- and small-cap equivalents to the fund over the same period. Many other experts are quick to point out that mid-cap stocks have the best risk-adjusted returns in the market.
Don’t overlook the middle. Check out this list of seven mid-cap stocks to buy for the best of both worlds — and most importantly, market outperformance.
Prices and data are from the original InvestorPlace story published on February 9, 2017. Click on ticker-symbol links in each slide for current prices and more.
All of the biggest trends in tech — cloud computing, mobile commerce or big data — all require massive computing systems and storage. But it’s awfully cost-prohibitive to buy all the necessary hardware and the specialized buildings they can require.
That’s where datacenter real estate investment trust (REIT) Digital Realty Trust, Inc. (DLR) comes in.
Digital Realty is the world’s largest datacenter provider with 156 different facilities under its umbrella. The mid-cap firm rents space in those locations to other companies to house and hold their server computers. DLR’s impressive client list includes the like of International Business Machines Corp. (IBM) and Facebook Inc. (FB).
Renting out space to these giants has produced ample cash flow to allow Digital Realty to keep cranking out higher dividends, too. DLR’s payout has grown 20% over the past five years, and the stock currently yields more than 3%.
Fatter margins could be on the horizon, too. Digital Realty purchased rival Telx in 2015. The deal doubled DLR’s footprint in the rapidly growing colocation segment and provided access to a leading interconnection platform. The crux of the deal is that services provide more profits than just hosting servers.
DLR is a perfect example of how mid-cap stocks give you the best of multiple worlds: here, it’s growth and dividends.
Mike Mozart via Flickr
It’s no secret that online shopping and e-commerce continues to stick it to brick-and-mortar retailers. But a few traditional retailers are managing to stay above the fray.
Case in point: Ulta Beauty Inc. (ULTA).
Ulta operates nearly 900 different beauty supply stores, selling mid-range, department store or salon-priced products. What I like about Ulta is that it’s focused on customer service; stores are staffed by trained beauty expert. Need to know what eyeshadow goes with your skin tone before you buy? Ulta’s experts can tell you … and apply it … and offer plenty of complementary products to go with it.
That experience — along with actual hair cutting and styling at certain locations — can’t be replicated online.
The focus on service — as well as things like rewards programs that nurture Ulta’s fanatical fanbase — has allowed the retailer to avoid the industry meltdown. While Macy’s Inc. (M) and Sears Holdings Corp (SHLD) have been busy falling apart, ULTA stock has been exploding, with shares up more than 200% in the past three years.
Also, Zacks portfolio manager Tracey Ryniec thinks Ulta is more than just one of the best mid-cap stocks to buy right now — it’s her pick in the InvestorPlace 10 Best Stocks for 2017 competition of stocks to buy and hold for one year.
U.S. Coast Guard image
The downturn in oil prices has decimated the oil services industry. Capital expenditures by producers are way down, so the industry has become a minefield.
But beaten-up mid-cap Transocean LTD (RIG) might finally be ready for a recovery.
Transocean, one of the largest and most technical deepwater and offshore drillers out there, was dinged up badly during the downturn. But management has paid down the debt load while refinancing near-term maturities. The company has also managed to boost its cash hoard to more than $2.5 billion as of the end of last quarter.
RIG has been working on operational servings, including selling, cold-stacking and even scrapping rigs to save money, not to mention some substantial layoffs. In the end, Transocean has been able to get operational costs down — necessary during oil downturns, but also conducive to better margins when conditions improve.
Let’s be clear: Transocean still needs higher oil prices to produce meaningful profits. But management has put this company in position to be one of the best-performing mid-cap stocks whenever oil makes another meaningful march north.
Mid-cap stocks occasionally have huge built-in potential to rocket higher thanks to a single event or driver.
Regarding Motorola Solutions Inc. (MSI), that “event” is spelled “T-R-U-M-P.”
Motorola Solutions — the parent company that spun off Motorola Mobility back in 2011 — is a leading provider and manufacturer of emergency response communications equipment. So, think the radios, headsets and other gear that firefighters, law enforcement, and the military need to do their jobs.
It’s not the most exciting technological niche in the world, but it’s a profitable one with few competitors, as much of the equipment has to satisfy rigorous specifications.
Where does President Donald Trump come in?
Trump has made law enforcement and military spending some of his top campaign promises, and it looks like he means to follow through, if a trio of executive orders signed recently are any indication. If spending on law enforcement and military does in fact increase, MSI is one of several stocks that will benefit.
Analysts currently expect Motorola Solutions to grow profits by just 4.5% this year, and 7.6% next. Meanwhile, MSI trades at about 14 times forward earnings. That’s a little expensive given its current growth prospects, but that looks a lot more fair considering the prospects by increased spending by many of Motorola’s customers.
MSI also offers a decent 2.3% dividend while you wait for the growth to kick in for this mid-cap stock pick.
Specialization is one of the highlights of investing in mid-cap stocks. And Omega Healthcare Investors Inc. (OHI) operates in a very lucrative niche market indeed.
Omega Healthcare is, as the name implies, dedicated to healthcare-related real estate, providing capital and making loans to property owners to build out their facilities. The vast bulk of OHI’s loans have been so-called sale-leaseback transactions. This means that after a period of time, OHI will buy the building and the tenant will continue to lease the property from Omega.
OHI’s particular focus is skilled nursing facilities and assisted living facilities. Skilled nursing facilities have higher margins than the most medical real estate, while lending money pushes the construction risk to the borrower. Then Omega swoops in and just collects a rent check later on.
The stock is trading for a bit of a discount after the company announced guidance for fiscal 2017 funds from operations (FFO) that slightly missed estimates. But that report included significant beats on both the top and bottom lines for the most recent quarter. And earlier this month, OHI extended its multiyear streak of quarter-over-quarter dividend hikes.
All told, I still believe in OHI, which at a yield of 8% offers one of the safest large yields you can find among mid-cap stocks.
Once the largest company in the world, United States Steel Corporation (X) is only a mid-cap stock today. U.S. Steel, of course, is one of the hardest-hit victims of America’s collapsing steel industry.
But at least for the intermediate-term, X could be poised for a resurgence.
President Trump’s plans to build out our nation’s roads, bridges and other infrastructure facilities bode well for U.S. Steel and its flat-rolled operations. In fact, given Trump’s “America First” stances, the chances are good that American-produced steel will be at the forefront of his plans.
But X has another path to victory: higher oil prices. During the boom years, U.S. Steel became one of the largest producers of drilling pipe. Rising prices result in increasing drilling activity, which would send more producers in the steelmaker’s direction.
Fair warning: U.S. Steel is a mid-cap that has been on its way down, not up, and it’s currently a minefield of losses, high debts and industrial issues. This is a gamble — but one that could pay off in spades over the course of a couple years.
Perhaps the best way to invest in mid-cap stocks is to invest in a big bundle of them.
At just 0.07% in expenses — so, $7 annually for every $10,000 invested — the iShares Core S&P Mid-Cap ETF (IJH) is the cheapest fund that tracks the mid-cap space. And it offers some serious muscle.
The IJH tracks the S&P 400 — the same index as the MDY in the opening slide — and provides exposure to nearly 400 stocks, including all the picks on this list. That adds in mid-cap stalwarts such as Raymond James Financial, Inc. (RJF) and Domino’s Pizza, Inc. (DPZ).
With IJH, you can instantly add exposure to the best mid-cap stocks and gain from their superior long-term performance.
And the cheap annual expense gives you the most of the index’s returns.
This article is by Aaron Levitt of InvestorPlace. As of this writing he held none of the aforementioned securities.
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