Please ensure Javascript is enabled for purposes of website accessibility

The Advantages of Mid-Cap Stocks

Looking for a stock to feature in today’s Investment of the Week, I noticed that all my candidates had something in common: they were firmly in the “Mid-Cap” range of market capitalization. The range for a mid-cap varies by source, but usually includes companies valued between $1 billion and $10...

Looking for a stock to feature in today’s Investment of the Week, I noticed that all my candidates had something in common: they were firmly in the “Mid-Cap” range of market capitalization. The range for a mid-cap varies by source, but usually includes companies valued between $1 billion and $10 billion. The S&P Mid Cap 400 focuses on companies with market caps between $750 million and $3 billion, while the Russell Midcap Index includes stocks with market caps from about $1 billion to $20 billion.

However you categorize them, mid-cap stocks offer investors several advantages. They’re generally less risky than small-caps, but have more growth potential than large-caps. And they often have low institutional ownership, leaving lots of potential for growth as big institutions add the stock to their holdings.

Since I decided to make mid-caps the focus of my email today, I thought I’d share all three of the companies I was considering.

Top Performer in this Economy

The first is from Stealth Stocks, edited by Dennis Slothower. Slothower recently recommended United Rentals, Inc. (URI), an equipment-rental company with a $2.7 billion market cap. URI has gained an incredible 130% in the last six months, with a minimum of volatility.

The only mid-cap advantage URI doesn’t have going for it is low institutional ownership. In addition, URI’s impressive 130% gain means a correction is likely soon, especially if the broader market corrects. (Most analysts think it has to, sooner or later—click here to watch my latest Stock Market Crash Course video for a quick explanation of why.) But Slothower still thinks the stock has upside. Here’s what he wrote about it on March 12:

“This equipment-leasing firm is one of the top-performing companies in this economy, and it is not hard to see why. Construction firms would rather lease or rent than own equipment in this tricky economic climate. United Rentals had a truly blowout quarter—earnings per share increased a whopping 413%. The stock is in a very steady uptrend, setting new 52-week highs. I don’t know how much longer this bull market has, but this is one of the best companies I could find for outstanding growth potential.

“According to my numbers, URI should be selling in the $60 range. It is currently trading around $43; so URI has large upside potential. Place a sell stop at 25% below your entry price. As the stock rises, continue to raise your stop so that you are trailing the Friday close by 25%.”

Turnaround Situation

This next stock does better on the institutional ownership metric, with about 73% of the float in institutional hands. But you might not know it’s a mid-cap, because it’s so well known. The stock is The Wendy’s Company (WEN), which, though the company is famous, only has a market cap of $1.97 billion. WEN was once a much higher flyer, but the company stumbled over the past decade, and the stock followed. It’s in turnaround mode now though, as George Putnam, editor of The Turnaround Letter, explains below:

“After carving out a niche in the fast-food industry based on good-quality food and service, The Wendy’s Company has faltered in recent years, suffering from a stale menu and image. The company was acquired by financier Nelson Peltz in 2008, who combined Wendy’s with the Arby’s chain, which he already owned.

“Wendy’s has a number of the characteristics that we like to see in a turnaround situation: a well-known brand, renewed focus, a new management team with turnaround experience, decent financials and a large shareholder with a lot at stake. Wendy’s sold off the Arby’s franchise last year so that it can focus solely on the Wendy’s brand. Last September the company brought in Emil Brolick as its new CEO. ... Brolick is committed to restoring Wendy’s quality image, with particular emphasis on bringing back adult customers who have been lost in recent years. He also plans to enter the lucrative breakfast segment, which Wendy’s has missed out on until now. ...

“Peltz owns almost 100 million shares, which gives him a big incentive to get things back on track. While Wendy’s will probably always trail industry leader McDonald’s, a comparison of the two companies shows the gain potential in the Wendy’s stock. McDonalds (MCD) currently trades at a price-to-sales ratio of nearly four, while Wendy’s is around one. If business improvements caused investors to give Wendy’s a multiple even a little closer to McDonalds, the stock would move up significantly. Throw in an additional boost from continued improvement in the U.S. economy, and you have a recipe for tasty profits indeed. We recommend buying Wendy’s stock up to 8.”

Low Institutional Ownership

Today’s final mid-cap has the lowest institutional ownership of all three. Titanium Metals Corp. (TIE) has a $2.5 billion market cap, but only 66% of the float is in institutional hands. Like WEN, TIE has seen better days—the stock shot up over 1,000% in less than two years back in 2005-2006. But it’s back in the lower atmosphere now—and has actually had a pretty bad year.

That hasn’t deterred Nathan Slaughter, editor of Scarcity & Real Wealth. He’s convinced that investors are overlooking Titanium Metals’ incredible potential as a play on airplane manufacturing. Here’s his explanation of this mid-cap’s appeal:

“In the June 2010 newsletter, I outlined some powerful growth drivers for titanium. ... Older planes were (and still are) being retired to make room for newer fuel-efficient models such as Boeing’s (BA) snazzy 787 Dreamliner. Each of these engineering marvels weighs around 440,000 pounds, and titanium accounts for 15% of the construction materials. ... As the world’s No. 1 supplier, Titanium Metals Corp. (Timet) looked to be a major beneficiary.

“Given the decline in the stock, you might think that something went awry since then, or maybe the uptick in orders never materialized. But things have gone exactly according to plan. The company just released its final report card for 2011—and the results were excellent across the board. Shipments of raw melted titanium (ingots, etc.) reached 6.2 million metric tons, a new company record. Milled product sales surged to 16 million tons, also a new record—and three million tons more than 2010. Those volume gains pushed revenues up a healthy 22% for the year to $1 billion.

“Better still, increased factory utilization helped lower per-ton manufacturing costs, so operating profits sprinted at twice that pace, jumping 44% to $175 million. As predicted, the aerospace sector has stepped up its titanium purchasing to build inventory in anticipation of fleet replacement and overall aircraft production. And Timet continues to win more than its fair share of these orders. In fact, the company has renewed its supply agreements with a number of big customers such as Boeing in recent months, along with engine makers Rolls Royce and Pratt & Whitney—these commitments will remain in place until at least 2017.

“The future looks even brighter. With orders coming in faster than they can be shipped out, the firm’s backlog ended 2011 about 33% higher than where it began. ... Last June, I thought Timet was an attractive buy at around $18 per share. Today, the company has $190 million more in the order backlog bank than it did then, yet the shares can be had for 25% less. ... I plan to capitalize on this disconnect by adding another 100 shares of Titanium Metals.”

TIE is definitely an investment for patient investors—unlike URI, which may have a little too much momentum, TIE has zero. But, as with WEN, the story here is convincing enough to merit adding TIE as a long-term holding.

Wishing you success in your investing and beyond,

Chloe Lutts

Editor of Investment of the Week

Chloe Lutts Jensen is the third generation of the Lutts family to join the family business. Prior to joining Cabot, Chloe worked as a financial reporter covering fixed income markets at Debtwire, a division of the Financial Times, and at Institutional Investor. At Cabot, she is a contributor to Cabot Wealth Daily.