Drop in on a water-cooler conversation about the stock market, and most likely your colleagues will be discussing the Dow Jones industrials or the NASDAQ. Good bet they're not talking about the Standard & Poor's MidCap 400 index or mid-cap stocks, the often forgotten sector of the market.
Maybe they should. If you're looking for tomorrow's great companies, seek candidates among midsize companies. The better-run among them have more growth potential than the large-caps, and more financial wherewithal than many small-caps.
Not that midcaps staged a bull market in recent years. But on Wall Street, relative performance counts, and the midcaps did relatively well compared with larger companies. The S&P MidCap 400 fell 6.3% during the three years ending Feb. 14. That performance trounced the S&P 500-stock index, which lost 35.3% in the same period.
Still, there are stars even in a bear stock market. To help investors identify those companies, BusinessWeek examined the performance of the S&P MidCap 400. We measured and ranked both the one- and three-year total returns for all of the stocks in the index, then we added the two rankings to come up with the best performers, the Mid-Cap 50 (table).
These companies are a varied lot. Scanning the list shows 21 companies in three broad groupings -- food, health care, and banking. None of those should be a surprise. Even in a weak economy, people don't stop eating or needing health care. And these financial-service companies thrived, largely thanks to low interest rates and a robust residential real estate market.
Americans especially gorged on comfort foods, sending sales up 11% last year and profits up 13% at Dreyer's Grand Ice Cream Inc. (DRYR
) -- No. 1 on our list. The Oakland (Calif.)-based company makes ice cream under the Dreyer's, Edy's, and Godiva brand names. The company's strong performance has attracted a suitor, Swiss food giant Nestlé (NSRGY
). Although U.S. regulators have held up Nestlé's acquisition of Dreyer's on antitrust issues, the deal is ultimately expected to be approved.
Just because we indulge in ice cream doesn't mean we aren't trying to eat healthier food. That's why Whole Foods Market Inc. (WFMI
), a 143-store organic food supermarket chain based in Austin, Tex., is No. 9 on our list. Its stores keep drawing new customers and more business from repeat customers: Same-store sales are up an average of 10% in the last six quarters, compared with negative same-store sales at many regular supermarket chains. Why the success? "We showed people that eating well can be a gourmet experience," says CEO John P. Mackey, who founded the first market in Austin in 1980. "Earlier, the view was that people who enjoyed life weren't eating well, and those eating well were ascetic."
Consumer preference for healthier foods is doing wonders for Dallas-based Dean Foods Co. (DF
) Sales of Silk, its soy milk, jumped 60% in the fourth quarter vs. the same period in 2001. Sales are strong because soy milk is cholesterol-free and studies show it contains cancer-fighting substances and fights osteoporosis. It's also pitched as a dairy substitute for those who are lactose intolerant. David C. Nelson, an analyst who follows the company for Credit Suisse First Boston, applauds Dean's recent agreement to provide its Silk to 4,000 Starbucks stores. "We believe the exposure from the brand in Starbucks will be very beneficial," says Nelson.
And as people focus more on caring for themselves, they're also taking good care of those around them, especially their pets. Not only are they spending more on their pets, but pet ownership is growing. At last count in 2001, there were 61.6 million dogs and 68.9 million cats as house pets, according to the American Veterinary Medical Assn. That helps explain why PETsMARt Inc. (PETM
), No. 2 on our list, is doing so well. The specialty retailer earned $89 million in its fiscal year ended Feb. 2, 2003, up 124% over the prior year. CEO Philip L. Francis says store remodeling helped boost sales, as did adding services like grooming and obedience classes. The company is also testing PETsHOTEL, a new concept of high-end hotels for dogs and cats where owners can lodge their pets when they go on vacation. The dogs aren't caged; they have a choice of rooms or suites and staff are devoted to serving them during scheduled "yap," "nap," and play times. "The dogs are on vacation as well," says Francis, who's trying out the inns at three sites and plans to open seven more this year.
Health-care companies that serve distinct niche markets are also doing well. Consider Steris Corp. (STE
) of Mentor, Ohio: It makes sterilization and decontamination equipment that hospitals need to service their diagnostic and surgical gear. Steris is also enjoying increased demand from pharmaceutical companies that need sterile environments to conduct experiments. All this led to a 90% increase in net income, to $53 million in the first nine months of the fiscal year ending mar. 30. That compared with $27.6 million for the same period in the previous fiscal year.
Steris, 11th on our list, is looking at ways to expand its customer base and even help the government if there is a chemical or biological attack. "We are working with the U.S. Defense Dept. to look at ways that we might apply our technology to fight battles in different environments with less potential harm to troops," says CEO Les C. Vinney, who also deserves credit for streamlining operations after he took over the top job in July, 2000. During the 1990s, Steris quickly increased its revenue from $70 million to $700 million after acquisitions and mergers with 12 different entities. Vinney cut costs, closed some manufacturing facilities and consolidated others, and slowly established a path to growth. After a 12% increase in revenues in 2002, he expects sales to increase at least 11% in 2003.
Technology improvements also boosted Palo Alto (Calif.)-based Varian Medical Systems Inc. (VAR
) Varian developed Intensity Modulated Radiation Therapy, a system that allows doctors to focus more sharply on tumors while giving higher doses of radiation. The company has a 9-month backlog of orders for the system. Another gainer is Lincare Holdings Inc. of Clearwater, Fla., which provides in-home oxygen and other respiratory-therapy services to patients who suffer from emphysema, chronic bronchitis, or asthma. William R. Walker, managing director of Mason Street Advisors in Milwaukee, owns Lincare (LNCR
) in his aggressive growth portfolio. "It has made small and cheap acquisitions, which demonstrates efficient use of capital," says Walker, who also likes the company's financials. It logged $812 million in sales and $190 million in profits during 2002. That's a 40% profit gain atop an 18% increase in revenues.
Two financial-services companies with the best returns on our list are Fidelity National Financial Inc. (FNF
) (No. 4) and First American Corp. (FAF
) (No. 13). Both sell title insurance, which borrowers must purchase when they get a mortgage. Fidelity National's net income grew 75% in 2002, to $532 million, on revenue growth of 34%, to $5.1 billion. First American, a larger company, was not as strong -- it had a 40% gain in profits on a 25% increase in revenues.
If interest rates rise or the housing market softens, the title companies might drop down or even off the Mid-Cap 50 list. But there are always great new companies to take their place.
MARCH 24, 2003
By Pallavi Gogoi in Chicago
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