THings are good. Gretchen has gone bullish -g-
July 2, 2000
MARKET WATCH
The Happy Medium in Stocks
By GRETCHEN MORGENSON
The first half of a desultory stock market year is history. What investors may now be wondering is, will the past be prologue?
A lot of what worked for investors in recent years stopped working with a vengeance in the first half of 2000. The entire Internet sector, which had brought new meaning to the term growth stocks, has fallen flat. And some dearly beloveds among the momentum investing crowd -- Qualcomm, Cisco Systems and JDS Uniphase -- are well down from their historical, not to say hysterical, highs.
But while all eyes are on the disappointing action in many big-name, large-capitalization stocks, the enviable performance of a wide swath of the stock market has been all but ignored. That is the large group of stocks made up of lesser-known, medium-sized companies with market values of $1 billion to $10 billion -- the midcap stocks.
The Standard & Poor's 400 Mid-Cap Index is up 8 percent so far this year, compared with the loss of 1 percent in the better-known S&P 500 index and the 9 percent decline in the Dow Jones industrial average, both of which track big stocks. Medium-sized companies have also beaten the returns of smaller companies; the Russell 2000 is up only 2 percent this year.
"Something really did go right in the first half," said Marshall Acuff, market strategist at Salomon Smith Barney. And he reckons that the outperformance of midcap stocks will continue the rest of the year.
Acuff cites several reasons why these shares have been the sweet spot in the market of late. One is the growing investor obsession with value. Investors still want to buy stocks with rising earnings, but they are no longer willing to pay any price for the privilege. "What has been driving these midcaps is you get a lot of earnings growth at a reasonable price," Acuff said.
Medium-sized companies with 15 percent annual profit growth often trade at price-to-earnings ratios that are much lower than those seen in big-name stocks. Most of the companies Acuff favors trade at P/E ratios roughly equal to, not higher than, their earnings growth rates.
This value proposition has lured many money managers who had previously focused their buying on large-company shares. Recognizing that these stocks had become too expensive, Acuff said, many managers have begun to reach down to smaller companies that provide good earnings growth. Before their rapid rise, "Qualcomm and JDS Uniphase were midcap stocks," he said. "Managers downsized, found them, and off they went."
Another reason for midsized stocks' hot streak is the spate of mergers in which large companies, eager to keep their growth rates high, buy smaller, prospering concerns. Last month, for example, Texas Instruments paid $7.6 billion for Burr-Brown, an electronic components maker in Tucson, Ariz. Shares in Burr-Brown, a midcap company, rose 38 percent on the day the deal was announced.
Acuff says he thinks there will be many more such deals in coming months. "Consolidation continues to be a very powerful theme," he said. "If the Fed is going to be successful in slowing growth, most companies are going to be challenged from a profit standpoint. One way to get more growth is to consolidate."
Among the midcap stocks Acuff likes are Archer Daniels Midland, the agricultural products concern; the Allmerica Financial Corp., which sells insurance and retirement services products to individuals and institutions; Starwood Hotels and Resorts; the Avery Dennison Corp., an office products and adhesive label manufacturer, and John Hancock Financial Services.
These companies may not be as glamorous as those that investors have grown so fond of in recent years. But investors who hope their old favorites will spring back should remember that no stock market strategy remains profitable forever. The midcap sector is clearly having its moment in the sun. Investors should make hay. |
