Week 282 - “Moneyball” Revisited: The Art of Investing in MidCap Stocks

Situation: The S&P 400 MidCap Index is a very good investment. So let’s dig deeper and ask whether there are MidCap stocks that might represent an even better investment? We’ve toyed with this idea in the past (see Week 263 - “Bond-like” Stocks That Fly Under The Radar). Now we undertake a systematic study. 

Mission: Make a spreadsheet based on the 65 Dividend Achievers in the S&P MidCap 400 Index. Then remove companies that don’t have 16-yr trading records, or S&P stock ratings of at least B+/M. Remove companies where long-term debt accounts for more than 1/3rd of Total Assets, as well as companies that have been unable to make dividend payments over the past 2 quarters exclusively from Free Cash Flow, or have a Return on Invested Capital (ROIC) that is less than their Weighted Average Cost of Capital (WACC).

Execution: We find that only 8 companies meet our criteria (see Table).

Administration: Only one of those companies, Owens & Minor (OMI), pays a good and growing dividend. However, OMI had a total return of less than 6%/yr over the past 5 yrs, whereas, the other 7 companies returned at least 11%/yr. The good news is that 5 of those beat MDY (the S&P 400 Index ETF at Line 19 in the Table) and two (CHD and SON) are likely to lose less than the S&P 400 MidCap Index in the next Bear Market (see Column M in the Table). 

Bottom Line: None of these stocks looks to be a good “stand alone” bet. MidCap companies rarely have more than one product line. So, you would need to own stock in several to take advantage of “MidCap growth”. You would also have to pick those stocks to achieve an overall result that minimizes areas of vulnerability but maximizes areas of strength. That statistical exercise is now called “moneyball,” after the book by Michael Lewis (and hit movie) that explains how a young economist brought success to a major league baseball team that could only afford “MidCap players”. 

Risk Rating: 6 (for owning stock in all 8 companies)

Full Disclosure: I do not own stock in any of these companies, but do own shares of ARTMX (the “MidCap Blend” Mutual Fund at Line 18 in the Table) and a 401(k) clone of VEXMX (the “MidCap Blend” Index Fund at Line 21).

NOTE: Metrics are current for the Sunday of publication. Red highlights denote underperformance vs. VBINX at Line 20 in the Table. Purple highlights denote Balance Sheet issues and shortfalls. Net Present Value (NPV) inputs are described and justified in the Appendix to Week 256. Briefly, Discount Rate = 9%, Holding Period = 10 years, Initial Cost = moving average for stock price over the past 50 days (corrected for transaction costs of 2.5% when buying ~$5000 worth of shares). Dividend Growth Rate is the 10-Yr CAGR found at Column H. Price Growth Rate is the 16-Yr CAGR found at Column K in the Table (http://invest.kleinnet.com/bmw1/). Price Return (from selling all shares in the 10th year) is corrected for transaction costs of 2.5%. The Discount Rate of 9% is designed to approximate Total Returns/yr from a stock index of similar risk (S&P 400 MidCap Index at Line 26) to owning a small number of large-cap stocks, where risk due to “selection bias” is paramount.

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