Saturday, May 27, 2000

The Sophisticated Investor

Future bright for some midcap company stocks

By John Waggoner
USA Today

        When you look at kindergarten pictures, it's hard to tell which kid will be pulling down $300,000 a year at Lucent and which one will be doing two to 10 years at Leavenworth.

        But by the time you reach college, you can usually tell who is most likely to succeed. And that's one reason some of the best investors like midcap stocks. These companies are all contenders for the big money, but most won't wind up in the Big House.

        Midcap companies are the young adults of the stock market. Typically, they have a market capitalization of $1.5 billion to $11.5 billion. (Market capitalization is a company's share price multiplied by the number of shares outstanding.)

        For example, Staples, the large office-supply company, is a midcap company; it has a market capitalization of $8.2 billion. By contrast, Wal-Mart, the huge retailer, is a large-cap company; it has a market cap of $252 billion.

        Midcap stocks have held up well this year, while their larger and smaller relatives have crumbled. The average midcap stock fund is up 3.7 percent, vs. a 2 percent loss for large-company funds and a 2.9 percent gain for small-company funds.

        Why haven't midcaps been badly clawed? One possibility: The hottest money went elsewhere — to large-cap be hemoths such as Cisco Systems and to Internet initial public offerings, said David Alger, manager of Alger Mid-Cap Growth.

        “It was a barbell effect between the big, high-flying tech stocks and a huge group of small, dot-com companies,” he said. When the hot money fled, large-cap and small-cap stocks were left out in the cold.

        Many midcap stocks didn't get driven up as far, so they didn't fall as far, either.

        And some think midcaps' resilience points to a broadening in the stock market — which means that investors can look at stocks outside the technology sector. “It's never a smooth transition, but we think the market is broadening out,” John Calamos of Calamos Growth fund said.

        Choosing midcap stocks isn't significantly different from evaluating large-company stocks, according to Ron Tartaro, co-manager of Alger Midcap Growth. “By the time a company reaches midcap level, it's a reasonably dominant company,” he said. “Unlike small-company stocks, you don't have to worry that it will be crushed because it's not in a dominant position.”

        And in some respects, it's easier to evaluate a midcap company than a giant company, said Wallace Weitz, manager of Weitz Partners Value. “It's considerably easier to evaluate a North Fork Bank than a Citigroup,” he says.

        So your choice of midcap companies depends largely on old-fashioned stock analysis: figuring how much to pay for a company's earnings. Some like to buy cheap.

        „Chris Davis, who oversees the team-managed Davis Growth Opportunity fund, looks for companies with good records in industries that no one is interested in. That way, he gets the stocks without paying too much.

        “Boring is beautiful,” he said. One of his favorites is Host Marriott, a real estate company that owns upscale hotels. It earned 87 cents a share the past 12 months, and analysts expect it to earn $1.75 this year — a 101 percent increase.

        „Wallace Weitz takes a similar approach. One of his favorites, North Fork Bank, has seen its stock crushed the past 12 months, down nearly 30 percent. But the regional bank is a serious cost- cutter, and its manager has a good eye for buying other banks. And now its price, relative to its earnings, is low even for the battered regional-bank sector.

        „Mr. Alger and Mr. Tartaro of Alger Midcap Growth want steaming-hot earnings growth, and they are willing to pay for it. That led them to Starbucks, the ubiquitous coffee retailer. They expect 30 percent earnings growth, juiced in part by its strategy of selling its coffee and ice cream in supermarkets.

        „Mike Hershey of Henlopen Fund looks for themes and searches for stocks that fit his thesis. For example, he figures energy prices will stay firm — and that led him to Nabors Industries, one of the world's largest drilling contractors.

        What if you don't want to choose your own stocks? You can buy midcap Spiders (ticker MDX), which track the Standard & Poor's 400 midcap index. You can also buy Vanguard Mid-Cap Index fund (800/662-7447), which also tracks the S&P 400.

        Investing in a midcap stock or fund doesn't mean you will be shielded from a major stock decline. “We haven't found that price swings are more irrational in midcap stocks than in larger ones,” Chris Davis said.

        On the other hand, midcaps are far less likely to fail and wind up on the Boot Hill Exchange than small companies. And if you're looking for tomorrow's Microsoft, it's likely to be a midcap today.


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