Stock markets and families may have more in common than meets the eye. In both cases, the biggest and smallest members get the most attention, while those in the middle can often go unnoticed. So it was in 2007, a year when shares of the largest and smallest companies generated much of the news. Experts held court on a flight to quality large-cap stocks as investors grew more cautious. All the while, mid-cap stocks somehow went neglected.
In a way, that’s fine with Eric McKissack, co-founder and CEO of Chicago-based investment firm Channing Associates, which has $700 million in assets under management. His sights are set on corporations with a stock market value between $2 billion and $15 billion. Mid-caps, McKissack argues, offer a bit of the best attributes from both ends of the market. They tend to be more stable than newcomers and their potential to deliver big leaps in appreciation is more akin to their smaller siblings.
In recent years, mid-caps have had their way with the market. While the large-cap S&P 500 posted average annual returns of 13.9% over the five years ending Oct. 1, 2007, the S&P Midcap index rewarded investors with 17.8% a year over the same stretch. But as 2007 drew to a close, short-term results indicated that the financial world’s credit crunch and the subprime mortgage fallout may be shifting the tide toward large-caps.
As a value investor, McKissack says that though the pickings in the market’s middle tract may have thinned, there are still solid investments to be found.
What’s the earnings outlook for mid-caps in 2008?
At the end of the most recent quarter, our portfolio traded at a price of 15 times next year’s earnings estimates. That’s slightly higher than the benchmark we use to track our performance–the Russell Midcap Value index–which was set at 14.6 times 2008 estimated earnings. Our holdings, meanwhile, have an estimated 15% five-year average annual earnings growth compared to 9.2% for the index. The difference in projections and values probably lies in the fact that we are not “deep” value managers that focus just on a stock’s worth, but that we often take positions in companies with sizeable growth projections in the future.
That’s pretty high growth for a value investor,
no?Well, we typically find companies with good opportunities that at the same time have a cloud over them. We take a position if, after our research, the picture is brighter than it seems over a long-term horizon of three to five years. In some instances investors may have been scared off by complex circumstances. If we’re willing to sort things out we can find good values.
What’s an example of a stock you think has been unjustly hit?
Fiserv (FISV) fits that mold. The company provides data processing and information management for banks, although it has branched out into similar services for health care and retirement plan administrators as well. It happens to be one of the leading online banking service software providers around, so it’s at the forefront of a very good trend–namely the growth of Internet transactions and bill paying. Still, Fiserv has been tainted with a negative image now that financial institutions and banks are undergoing heightened scrutiny. The stock’s valuation is attractive in our eyes. It trades at 16 times its 2008 earnings-per-share estimate while we see a 15% or more annual growth rate ahead–no matter what happens to interest rates or credit markets.
There are worries that consumer spending is in the doldrums. Are any of your portfolio holdings affected by that?
Phillips-Van Heusen Corp. (PVH) is. The company participates in a number of segments of the fashion market. We like the significant licensing deals the company has with a number of brands, including Calvin Klein. Phillips-Van Heusen has done good work to strengthen and reposition its name by both manufacturing products, and in other cases farming out fragrances and jeans to another firm. The company is helping to bring Calvin Klein to profitability on par with Ralph Lauren. It has done similar things with the Izod and Geoffrey Beene labels in addition to its old standbys Arrow and Van Heusen, in each case raising returns by building and strengthening brands. The stock trades at 13 times 2008 earnings, while we see growth of 15% to 16% annually over the next five years.
You’ve described another type of stock in your portfolio as a whole that is greater than the sum of its parts. What’s an example?
We think The Brink’s Co. (BCO)–the old security and armored car outfit–fits that description. A few years ago it was a conglomerate with an air freight unit that was losing money. The company sold off its freight unit to complete a transformation and exit from businesses, such as coal mining, that are outside of its present core operation. Now there are shareholders clamoring for the company to split its home security business from its traditional money transport and coin sorting and packaging operation.
One reason is that home sales are down and investors worry that the slump could affect Brink’s. Look more closely at the business, however, and you see that home security doesn’t need new contracts in order to turn a good profit. Each new contract requires an up-front installation of equipment, but Brinks makes most of its money once a system is in place and its cash flow for any one account improves. We value the company in its entirety at $75 to $80 a share and see 15% growth for Brink’s, which trades at about 20 times 2008 projected earnings.
McKissack’s Picks
| 52-week Price Range | ||||||
| Company (Ticker) | Price | Low | High | 2007Est. EPS | 2007 P/E Ratio | Comment |
| The Brinks Co. (BCO) | $59.64 |
$52 |
$68 |
$3.07 |
19.4 |
Security firm is worth more than the value of its home and bank security units individually |
| Fiserv (FISV) | $51.91 |
align=”center”>$44 |
$60 |
$3.20 |
16.2 |
Online transaction growth should insulate profits of info mgmt. firm from financial industry woes |
| Phillips-Van Heusen (PVH) | $41.91 |
$41 |
$62 |
$3.71 |
11.3 |
The apparel company’s makeover of Calvin Klein should lift returns |
source: yahoo! finance