10 Mid Caps to Rule Them All

Seeking out the 10 mid caps to rule them all is the only logical follow-up to seeking the 10 small caps to rule them all. Unlike small-cap companies that offer investors the potential for high-risk, high-reward returns, mid-cap companies usually have significantly less risk built in because of their proven business track records. These companies offer either distinctive products or exceptional value to investors -- or possibly both.

For reference, here are the choices for the previous four weeks:

This week, I'm going to look beyond our borders and into a sector that would make most investors in the U.S. cringe in horror -- housing. Specifically, let's take a closer look at why Gafisa (NYSE: GFA  ) may be a stock with a solid foundation.

What it does
Gafisa is a homebuilder in Brazil's burgeoning housing market. The company caters primarily to middle- and upper-echelon homebuyers, but also has business segments catering to lower-income entry level housing units.

Considering that China is suffering from its highest inflation readings in nearly three years, Brazil may just be the most stable of the fast-growing BRIC countries right now. Its government has been able to steadily raise interest rates to curb dangerous levels of borrowing while maintaining steady growth in the financial and housing sectors. Projected to grow gross domestic product by 5% in 2012 and following continued plans to inject capital into the My House, My Life low-income housing initiative, the housing market in Brazil looks healthier than ever.

How it stacks up
You'd think that measuring Gafisa up against some of its closest rivals would be a piece of cake -- but you'd be sorely mistaken. Being one of the few Brazilian companies that trades on the U.S. exchanges, the most direct comparisons that can be made to Gafisa are U.S. homebuilders that cater to middle- or upper-class consumers -- namely KB Home (NYSE: KBH  ) , Toll Brothers (NYSE: TOL  ) , and DR Horton (NYSE: DHI  ) .

I know some of you will call me out for the apples to oranges comparison of the Brazilian and U.S. housing situation, but when given a choice between U.S. homebuilders and Gafisa, the figures are so staggeringly biased it's not even funny:

Company

Forward P/E Price/Book PEG Ratio
Gafisa 6.7 0.94 0.19
Toll Brothers 45.1 1.31 83.92
KB Home 26.5 1.59 (0.76)
DR Horton 19.2 1.33 2.99
PulteGroup (NYSE: PHM  ) 27.9 1.27 (7.82)
Lennar (NYSE: LEN  ) 16.9 1.19 7.14

Those aren't misprints folks. Those are strongly biased figures that show negative growth projections for KB Home and Pulte, while Toll Brothers will be lucky to eke out any growth over the next five years. DR Horton and Lennar both show promise but are both trading well above book value and at PEGs of three and seven, respectively. Compare that to Gafisa's PEG ratio of less than 0.2 and it's clear that Gafisa is a growing force to be reckoned with.

How it could make you money
While Gafisa doesn't stand to make as much as its nonpublic rivals in Brazil do on the My House, My Life initiative, the company continues to produce solid results, having grown by 17% over the past five years. As interest rates continue to tighten further, the only class in Brazil that will really feel the pinch are the lower-income consumers who rely on bank lending to support their first home purchase. What this means for Gafisa's primary customer base is the continued ability to purchase homes. Brazil has done a phenomenal job of controlling inflation and it has translated into huge profits for Gafisa.

The company is also fairly conservative with its use of cash. Although the company's margins have recently been affected by the sale of lower margin condominiums, Gafisa is historically a stronger company in the second half of the year. The company's backlog showed a 39% improvement over the year-ago period in its latest quarterly filing, and that should easily return the company to positive operating cash flow in no time.

Trading at just a fraction of the price of its competitors based on its earnings and book value, it's no secret why Gafisa joins the ranks as a mid cap to rule them all.

Would you add Gafisa to your portfolio? Share your thoughts in the comments section below and consider adding Gafisa, as well as your own personalized portfolio of stocks, to your watchlist to keep up on the latest in the homebuilding sector.

Fool contributor Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy that always knocks before entering.


Read/Post Comments (3) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 16, 2011, at 12:46 PM, TDRH wrote:

    One risk you did not mention was the currency risk. The Reais is current trading at 1.6075. It has been on a downward trend for a number of years. That said, if the dollar strengthens from this point, the earnings and book value you mention will decline.

    Not sure if this is the bottom for the USD, could be that it could slide further and your position would improve. My gut says the dollar has more upside than downside risk from this point.

  • Report this Comment On June 16, 2011, at 4:05 PM, BodUK wrote:

    An excellent article and investing in this stock is a no brainer. Well run company and with very good financials and great potential. Anyone believing the housing markets world wide will recover will want to look at this stock as one of their first choices

  • Report this Comment On June 30, 2011, at 2:59 AM, scottinbrazil wrote:

    TDRH, I don't know how you get that. The Real has been gaining vs the US dollar for over five years if you exclude the flight to (dollar) safety spike in 2008. And this is despite the fact that the Brazilian government has been buying US dollars at times to try to keep the Real from gaining further. 5 years ago the real was at 2.2 to the dollar and today it's 1.6 - that means 1 dollar equals 1.6 Reals where it used to equal 2.2 Reals. So the dollar is weaker against the Real than it used to be. What does your gut tell you about the effect of the growing US debt on the value of the dollar. Do you think it will help? ;-)

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