If you're like most investors, you probably split the stock universe into two groups: Large caps and small caps. But lost in that two-party system are some of the market's best investment opportunities.
Mid-cap stocks suffer from the classic middle-child syndrome. Unlike large-cap blue chips, most mid caps are not widely known household names. And though they're smaller than the large-cap crowd, mid caps aren't as small as the small caps and don't provide investors with the same "the sky is the limit" feeling.
But because so much focus is fixed on the upper and lower end of the market, investors can often find bargains hiding out in the mid-cap no-man's land. With that in mind, here are three specific mid cappers that are currently on my radar.
Portfolio Recovery Associates (Nasdaq: PRAA )
I've often thought to myself that it'd be great to start a debt purchasing and collection business. Not, mind you, because I like hassling people about money they owe, but because the business is an elegant, numbers-driven affair. Since I doubt my start-up plans will be taking shape any time soon, I may do the next best thing and invest in Portfolio Recovery Associates.
In a recent presentation, PRA writes that its "competency is sourcing, underwriting, and managing portfolios of high yielding assets." Essentially, this means that the company fancies itself good at finding debt to buy and knowing how much to pay for it so that it's able to earn an attractive return for its investors. What's great about this business is that we don't have to take PRA at its word on that. The company's results, based on buying more than $41 billion in face-value debt over the past 15 years, show that it does, indeed, have a knack for doing what it does.
PRA has been on at least the periphery of my radar for a long time thanks to my Foolish colleague Jim Gillies. I also gave the stock a thumbs-up in my Motley Fool CAPS portfolio back in 2009 -- a rating I plan to stick with. While I really wish I had picked up shares back when I rated the stock in CAPS -- it's more than doubled -- today's valuation still looks attractive.
BorgWarner (NYSE: BWA )
Earlier this year it was reported that the average age of cars and trucks in the U.S. is 10.8 years. That's the highest since... well, ever. Or, at least as long as the Polk research group has been tracking it.
We all know the drill -- you can push your car just a little bit longer, but eventually you have to give up the ghost and head back to the dealership. To me, old cars signal pent-up buying demand.
It's tempting to want to go with one of the major global manufacturers -- say, Ford (NYSE: F ) , General Motors, or Volkswagen -- but rather than try to pick a winner there, I'd rather try to find a company that can win along with multiple auto manufacturers. Enter BorgWarner.
If BorgWarner could be described in a word, that word would likely be "efficiency." The company's key products help cars become more fuel efficient, produce fewer emissions, and perform better. Ford, GM, and Volkswagen are all among BorgWarner's customers, but so are BMW, Fiat, Renault, Caterpillar (NYSE: CAT ) , and John Deere.
The company doesn't buck economic downturns or lulls in the auto industry -- 2008 and 2009 were both gnarly years for BorgWarner. On balance though, the company performs admirably -- average annual return on equity for the five years ending in 2011 was 11% despite an unprofitable year in 2008 and a barely profitable 2009.
With a trailing EBITDA multiple of 7.3, BorgWarner is on the cheaper end compared to the broader market. However, it's not particularly cheap compared to the stock's trading history. That said, I like BorgWarner here -- and have given it a thumbs-up in CAPS. At the very least, this is a company worth keeping on your radar.
Hillenbrand (NYSE: HI )
Hillenbrand is a leader in burial caskets.
Yes, you read that correctly. In addition, the company sells cremation caskets, urns, and other memorialization products for funerals. The Batesville business is more than 100 years old and it's been a darn good one for Hillenbrand -- investors have been treated to healthy margins and strong cash flow. The company has been returning some of this cash to investors through dividends; the stock currently yields 4.2%.
But there's a problem here. While there's opportunity for Hillenbrand to increase its market share, the funeral industry isn't a growth industry.
The solution that management has come up with is to use its cash flow (and some fresh debt) to acquire growthier businesses in other industries. Over the past few years, Hillenbrand has acquired K-Tron International and Rotex Global. Combined, these two companies now make up Hillenbrand's Process Equipment Group.
Stepping back, this looks like a neat setup. Conceptually, a strong, cash-flow-generating machine being used to acquire attractive companies that will be accretive to earnings is a good idea. In practice, though, undertaking an acquisition strategy leaves Hillenbrand open to destroying shareholder value by overpaying for the companies it buys. And there's also new execution risk as the company adds businesses that are outside of its core competency.
I need to do some more research on Hillenbrand's deal-making prowess before I'm ready to give it a thumbs-up, but it's a company definitely worth tuning in to.
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