Please ensure Javascript is enabled for purposes of website accessibility

Not Just Any Mid-Cap Companies, but an “Enhanced” Selection

By Selena Maranjian – Nov 23, 2012 at 5:38PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

There are some very fast growers in here.

Exchange-traded funds offer a convenient way to invest in sectors or niches that interest you. If you'd like to add some medium-sized companies to your portfolio, the First Trust Mid Cap Core AlphaDEX (FNX) could save you a lot of trouble. Instead of trying to figure out which companies will perform best, you can use this ETF to invest in lots of them simultaneously.

It's an enhanced index fund focusing on the 300 most promising components of the S&P Midcap 400 according to a proprietary system. The system seems to work, as the ETF has performed rather well, beating the S&P 500 over the past three and five years. As with most investments, of course, we can't expect outstanding performances in every quarter or year. Investors with conviction need to wait for their holdings to deliver.

ETFs often sport lower expense ratios than their mutual fund cousins. The First Trust ETF's expense ratio -- its annual fee -- is 0.70%, which is a bit higher than many ETFs, but also quite lower than the typical managed stock mutual fund. The fund is fairly small, too, so if you're thinking of buying, beware of possible large spreads between its bid and ask prices. Consider using a limit order if you want to buy in.

Why mid-cap companies?
Mid-caps can be wonderful additions to portfolios, because they've proven themselves to some degree, having grown to mid-cap size, but they also still have a lot of room to grow before they become large-caps.

More than a handful of mid-cap companies had strong performances over the past year. LKQ (LKQ), for example, surged 57% over the past year, primarily providing replacement parts and systems for vehicle repairs in North America and Central America. It has grown its revenue and earnings by an annual average of more than 25% over the past five years, but that's been largely via acquisitions, worrying some investors.

Polaris Industries (PII) jumped 48%, selling snowmobile and all-terrain vehicles (ATVs). Its revenue and earnings have been growing at accelerating rates lately, and have averaged more than 20% annually over the past three years. Even its dividend, which recently yielded 1.8%, has been growing nicely, averaging more than 10% growth over the past five years. Polaris's return on assets tops those of its peers.

Other companies didn't do quite as well last year, but could see their fortunes change in the coming years. Bearings manufacturer Timken (TKR) gained 9%, and sports an attractive valuation, with a current and forward P/E of about 7. Many like that the company is committed to manufacturing in America and not outsourcing its work, which offers both benefits and disadvantages. The company recently posted some disappointing quarterly results. Its shareholders have received an unsolicited mini-tender offer from TRC Capital to purchase up to about 2% of the company's outstanding shares, and Timken's management is recommending that they hang on to their shares. Its fans like its 2.3% dividend, strong return on equity, and solid growth prospects.

AECOM Technology (ACM), which offers architectural, engineering, and construction services, among other things, advanced 8%. Its revenue growth has been outstripping earnings, but free cash flow recently skyrocketed, easing investors' concerns about steep debt. The company is racking up business, with recent orders worth hundreds of millions of dollars, for government agencies and foreign nations. But a disappointing third-quarter report, along with reduced guidance, had some investors heading for the doors.

The big picture
A well-chosen ETF can grant you instant diversification across any industry or group of companies -- and make investing in and profiting from it that much easier.

Longtime Fool contributor Selena Maranjian, whom you can follow on Twitter, has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. Motley Fool newsletter services recommend LKQ and Polaris Industries. 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.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.