On Monday, I showed that the S&P 400 Mid-Cap Index has outperformed both the S&P 500 Index and the S&P 600 Small-Cap Index over the past 20 years.
The main reason is simple…
Many companies with medium-sized market capitalizations are at the optimal point in their growth cycle. As a group, their businesses are more established and stable than those of small caps, yet they exhibit higher revenue (sales) growth than large caps.
Because of this, we’d also expect the fastest-growing mid caps to outperform the entire S&P 400 over time.
Sure enough, the results further support my conclusion:
As can be seen in this backtest, the mid caps with five-year revenue growth greater than 10% have returned a cumulative 1,118% over the past 20 years, while the S&P 400 constituents have “only” gained 828%.
We don’t want to chase growth stocks, however. So the companies we invest in need to have reasonable valuations. Of course, we also like to see dividend growth.
Am I asking for too much? Apparently not, because mid caps with these qualities do exist.
Take a look…
Mid-Cap Growth Star #1: Cinemark Holdings (CNK)
Doesn’t it seem like movie ticket and popcorn prices rise every time you go to the theater? Well, here’s a way to profit from this frustrating trend.
Cinemark is a motion picture exhibitor with 334 theaters in the United States and 148 theaters in Latin America.
The company’s revenues grew 8.5% in 2013, in part due to a 3.0% increase in average ticket prices and 4.4% increase in concession revenue per patron. This is an example of inflation being passed on to you, the consumer, and Cinemark is a beneficiary.
Cinemark trades at a forward P/E ratio of 16.6x, and analyst consensus for long-term EPS growth is 18.5%. Talk about growth at a reasonable price!
To top it off, Cinemark also has a shareholder-friendly dividend policy, with a nice 3.4% yield.
But if you’re looking for more dividend growth…
Mid-Cap Growth Star #2: Reinsurance Group of America (RGA)
Reinsurance Group of America provides life reinsurance, which basically means that it takes over policies from other insurance companies that are looking to reduce their underwriting risks.
With offices in 11 countries around the world, it’s positioned for global growth.
The company has aggressively repurchased its stock through buybacks, resulting in a 4.3% decline in shares outstanding in the past year.
Its stock trades below tangible book value, and the company produces tremendous free cash flow. So those buybacks should create even more shareholder value.
The company just increased its dividend by 25% in July 2013. And while it still only has a dividend yield of 1.5%, there’s plenty of room for future payout increases with a forward payout ratio of just 15% (based on the latest dividend and analyst earnings estimates).
But if you’re looking for a higher current yield…
Mid-Cap Growth Star #3: Omega Healthcare Investors (OHI)
Omega is a healthcare real estate investment trust (REIT). The company focuses on skilled nursing facilities in the United States.
As my colleague, Richard Robinson, recently discussed, the smaller REITs often have higher dividend yields and lower valuations. And Omega is no different…
Omega’s estimated 2014 price/FFO (funds from operations) is 12.8x, which is lower than the industry average of 14.7x. It’s also below that of Ventas (VTR), one of the largest healthcare REITs, which has a 14.8x price/FFO.
Omega has a very attractive 5.7% dividend yield, which is higher than both the industry average and Ventas’ yield of 4.5%. The company has increased its dividend in each of the last seven quarters, which is great to see.
So there you have it…
Three solid mid caps with varying degrees of revenue growth, dividend growth and yield – but all with reasonable valuations.
These mid-cap growth stars are in the sweet spot of their growth cycles, and they definitely have what it takes to grow into large caps.
Safe (and high-yield) investing,
Alan Gula, CFA