Midcaps Are Where the Action Is
11/12/2012 11:15 am EST
You hear most investors talking about the security of large caps or the growth potential of small caps in an inflationary environment, but you rarely hear people gush about midcaps... and that's great, says Brian Lazorishak of Chase Investment Council.
Gregg Early: I’m here with Brian Lazorishak, who is portfolio manager of the 4 Star Chase Mid Cap Growth Fund (CHAMX).
Brian, there is a lot of talk in the markets about buying large-cap stocks for safety. And, in a highly inflationary environment, which people are talking about because of quantitative easing and the cheap dollar, small caps are the way to go. Now, you make the case for midcaps, and I think that it’s an important case to make, so I’d love to hear it.
Brian Lazorishak: We’ve liked midcaps as an asset class compared to large and small caps for some time. Obviously, we’re speaking to our own style a little bit there.
But the numbers really back this up: from a longer-term standpoint, they offer a pretty good risk-reward tradeoff. If you look at the ten, 20, 30 years ended 2011, midcaps have actually outperformed both large and small caps in terms of absolute return, with a risk profile somewhere between the two.
They're not necessarily the best absolute performer, but we think you get some of the benefits of small cap investing without as much risk as you see in small caps, both at an overall portfolio and individual company level.
Gregg Early: They’re kind of like the Goldilocks stocks, right? They’re a little bit more dynamic than the large caps with more growth potential, and yet they don’t have the risk of the wing-and-a-prayer that a lot of the small caps do?
Brian Lazorishak: That’s exactly right. You have companies that in many cases are at an earlier point in their growth curve, so they really have the ability to grow faster without the individual risks of being completely one-product companies, as many small caps are. They tend to have more seasoned management teams than you typically see with small-cap companies.
In many cases, they can grow faster than large caps by virtue of being very specialized and being in specific areas where the best growth opportunities are. Where some large-cap firms—because of their size—to continue to grow have to be so broad and so diversified that it can be difficult to grow much more than the economy.
Gregg Early: Right, and when they're so diversified, no one sector or division really affects the overall stock price. You could have good sales in something that might pop up, so they’re diversified to the point of just keeping themselves afloat to a certain extent. They’re looking more for safety than growth than a midcap would.
Brian Lazorishak: I think that’s right. The downside to diversification is what you just hit on. It is that a big, broad company—let’s take United Technologies (UTX), for instance—is so diversified that results in any one division don’t really move the needle.|pagebreak|
Whereas, a smaller industrial company, like one of the names we have in the portfolio, Quanta Services (PWR). About 70% of their business is electrical transmission related. That’s a very fast-growing area, so that business really drives the needle for Quanta. Whereas, even though United Technologies is so big, I assume they have some exposure in the area, it’s not enough to grow at the same rate.
Gregg Early: Are you seeing specific sectors where these midcaps are especially dynamic, or can you find them across the board?
Brian Lazorishak: You can really find them across the board. The Russell Mid Cap Growth is our benchmark for the Chase Mid Cap Growth Fund. Some of the heavier weightings in that index are in consumer discretionary and technology.
We’re finding plenty of opportunities in those areas, but we’re also finding opportunities in other areas like health care and materials and industrials. Really across the board. Again, it seems to me that within the midcap space you can always find an attractive area.
Gregg Early: Are any of these companies, are they pure growth plays or do some of them carry some dividends with them as well as sort of total return plays over the long term?
Brian Lazorishak: We have a few stocks with dividends, a couple utilities. We've owned one for a very long time, American Water Works (AWK). It has a decent yield, and a few other companies have a yield, but it’s not really the focus of what we do.
We’re really trying to identify growth first and foremost. We do have a valuation component to what we do, but it’s not really related to the dividend yield on the companies.
Gregg Early: Do you hold these companies? What’s your time frame on that? Are these trades, or are they more long-term holdings?
Brian Lazorishak: No, we look at them as longer-term holdings—investments rather than trades, if you will. Granted, because of the technical component of our process, we have higher turnover. And I wouldn’t necessarily consider us a buy-and-hold investor.
The fund has an average turnover somewhere around the 100% level over time. When we’re evaluating a stock, we’re usually looking at a 12- to 18-month horizon and trying to make estimation of what the stock could do over that time. The actual holding period can be much shorter or much longer than that, but that’s the time horizon we’re focusing on when we make new buys.
Gregg Early: Do you have any that are eye-catching, especially these days?
Brian Lazorishak: Well, what's the old saying? Love all of our children equally? I think we tend to like all the names in the portfolio; that’s why we own them. Not necessarily as favorites, but I think there are a few names that really highlight kind of the way we look at the world in terms of our investment process.
One of those is a company called Polaris Industries (PII). Polaris is a power sports vehicle provider and manufacturer. Polaris makes off-road vehicles, although it actually got its start in snowmobiles; that’s a relatively small part of their business now.
What we like about this company is it’s been a very consistent growth story. It just grows earnings year after year at about a 20% rate. This year, they’ve accelerated that earnings growth somewhat, so they’re going to grow earnings in excess of 30% this year.
Because of new product innovation, because of just dominant market position in some of their key areas, they continue to have a strong outlook. For that 20% growth, you’re paying less than the growth rate in terms of the forward P/E. It’s about 18 times forward earnings.
Any time we can get a company for a P/E of less than the growth rate, that’s pretty attractive...if we think that growth rate is going to continue.