Markets & Finance

Stovall: The Case for Mid-Caps


Mid-cap stocks are expected to post better earnings growth than their larger counterparts—and may have more upside in a market recovery

From Standard & Poor's Equity ResearchYear to date through June 12, the Standard & Poor's 500-stock index fell 8.8%, with eight of its 10 sectors in negative territory. Yet the S&P MidCap 400 index declined less than 1% in the same period, with seven of its 10 sectors down on the year, with Utilities off only 0.1%. What's more, since the market's bottom on Mar. 10, the S&P MidCap 400 jumped 14.4% compared to the S&P 500's rise of 5.2%.

Why the disparity?

S&P thinks it could be for at least three reasons. First, investors realize they can get higher-octane results from the more nimble stocks in the lower-capitalization groups, as they typically outpace larger-cap issues when the equity market is on the upswing.

But the mid-caps also maintain the more defensive qualities that larger-cap multinational companies traditionally offer during challenging economic periods. While they're not multibillion-dollar behemoths, mid-cap companies often have the ability to leverage their relatively large size by entering into more favorable supply contracts. Mid-cap companies are also likely to have a greater percentage of their revenues derived from overseas operations than smaller ones, thus allowing them to benefit from the currency-conversion tailwind offered by a weak U.S. dollar.

Companies that Benefit from Rising Oil

The second reason the S&P MidCap 400 could be outperforming its larger-cap sibling is the makeup of the index itself. Even though the Financials and Information Technology sectors are among the largest across all index-cap sizes, significant disparities are found in the high-flying Materials and Utilities sectors. These two groups each represent less than 4% of the weighting of the S&P 500, but make up more than 8% of the S&P MidCap 400.

In addition, while the international integrated oil companies dominate the S&P 500 Energy sector, it's the upstream Exploration & Production companies (those that benefit most from rising oil prices) that dominate the mid-cap benchmark.

Finally, S&P equity analysts, who cover about 70% of the companies in the S&P MidCap 400 index, are projecting a 16% increase in operating earnings for the "400" in 2008, as compared with only an 8% estimate for the S&P 500. Plus, despite a higher price-to-earnings ratio on 2008 estimated earnings-per-share for the mid-cap index, the PEG (P/E-to-Growth) on 2008 estimated results is more attractive for mid-caps at a multiple of 1.0 times, vs. the 1.8 times for the "500." And based on consensus estimates for projected five-year EPS growth, the PEG is the same for both at 1.2 times. As a result, we think mid-caps will likely continue to lead the "500" in the period ahead.

Industry Momentum List Update

Here is this week's list of the industries in the S&P 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500), along with a stock that has the highest S&P STARS (tie goes to the issue with the largest market value).

Subindustry

Company

Ticker

S&P STARS Rank

Price (6/12/08)

Coal & Consumable Fuels

Peabody Energy

BTU

3

$78

Construction & Engineering

Fluor Corp.

FLR

4

$182

Diversified Metals & Mining

Freeport-McMoRan Copper

FCX

3

$116

Fertilizers & Agr. Chem.

Monsanto

MON

4

$136

Gold

Newmont Mining

NEM

4

$48

HyperMarkets & Super Centers

BJ's Wholesale

BJ

4

$39

Industrial Gases

Airgas

ARG

5

$60

Integrated Oil & Gas

Chevron

CVX

5

$100

Oil & Gas Drilling

Noble Corp.

NE

5

$63

Oil & Gas Equip. & Svcs.

Superior Energy

SPN

5

$57

Oil & Gas E&P

Swift Energy

SFY

5

$60

Oil & Gas Storage & Transport.

Williams Cos.

WMB

4

$39

Railroads

Norfolk Southern

NSC

4

$64

Steel

Allegheny Technologies

ATI

4

$66

Source: Standard & Poor's Equity Research


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