Mid-Cap Stocks with Low PEG Ratios

During the past couple of years, I’ve observed that many investors buy stocks of very large companies and stocks of very small companies, but they neglect the stocks of mid-sized companies, i.e., mid-cap stocks. I think that’s a mistake.

Large- vs. Mid- vs. Small-Cap Investing

The stocks of large-cap growth companies comprise a sizeable portion of many portfolios. The portfolios of mutual funds, hedge funds, ETFs and individuals are overloaded with the likes of Facebook (FB), Amazon.com (AMZN), Alibaba Group (BABA), Alphabet (GOOGL), Microsoft (MSFT) and Apple (AAPL). Growth at all these very large companies is impressive, but as the companies grow even larger, sales and earnings growth will inevitably slow and investors will begin to look elsewhere for the next great growth company.

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Other investors seek the next Apple, Facebook or Amazon by investing in small companies with promising new ideas and products. Often a good-looking price chart of a young company will prompt investors to find out if sales and earnings are growing rapidly and if the company has a unique product or service.

Sometimes, investors can capitalize on a short-term opportunity and once in a while, they can hit a home run with a small company that fulfills its promises. But often, these little companies don’t reach their goals, and their stocks can create large losses in a hurry. (To avoid such losses, I suggest that you seek the advice of a professional. Tyler Laundon, Chief Analyst of the Cabot Small-Cap Confidential, has spent his entire career managing, consulting and analyzing start-up and small-cap stocks, so he knows how to find the most promising opportunities.)

I like mid-cap stocks, though. While investors chase the leading large-cap stocks to dizzying heights, and small-cap investors look to hit the ball out of the park, stocks in the middle-ground are often unnoticed and neglected. These mid-cap stocks offer buying opportunities at reasonable prices with less risk.

Growth stocks of all sizes have outperformed value stocks during the past couple of years and will likely continue to do so in the coming months. I believe the greatest opportunities will come from mid-cap companies that are growing rapidly with stock prices that are reasonable.

To screen out growth stocks with sky-high valuations, I rely on the PEG ratio to evaluate both growth and value.

The PEG Ratio Methodology

The PEG ratio is easy to calculate for any company, and many investment services offer PEG ratios in their company summaries.

I calculate the PEG ratio by dividing the price to current P/E (price to earnings ratio) by the forecast earnings per share growth for the next five-year period. (See below for an example of calculating the PEG.)

My Cabot Benjamin Graham Value Investor database of 1,000 stocks includes 299 stocks in the mid-cap category, which most categorize as stocks with a market cap between $2 billion and $10 billion. Seven mid-cap stocks in my database are Buy-rated, but one company stands out: Tech Data (TECD).

Mid-Cap Stock Tech Data (TECD) Offers Growth and Value

Tech Data (TECD) is one of the world’s largest wholesalers and distributors of microcomputer hardware and software. Tech Data’s customers are resellers, retailers and direct marketers.

Tech Data’s products include computer peripherals, security systems, consumer electronics, digital signage and mobile hardware. The company manages inventories to maintain sufficient quantities to achieve high order fill rates. It also attempts to stock only those products in high demand and with a rapid turnover rate.

The big event recently was Tech Data’s acquisition of Avnet’s Technology Solutions segment for $2.3 billion will vastly broaden the company’s ability to deliver tech products to major businesses. The integration of Avnet has gone smoothly and is ahead of schedule. Tech Data is now a leading distributor of laptops, tablets and printers, while the Avnet segment excels in storage, network servers and other data center products.

With a much wider product menu under one roof, the significantly larger Tech Data will attract companies like Cisco (CSCO), which has a huge appetite for tech products. Tech Data will have new ways to cross-sell and deepen its relationships with major client companies. The Avnet purchase will also improve Tech Data’s position in Asian markets, and provide synergies of $50 million in 2017 and $100 million in 2018, which will fall right to the bottom line.

Tech Data easily beat analysts’ forecasts for the quarter ended April 30. Sales surged 29% and EPS (earnings per share) soared 78%. Sales and earnings were bolstered by the Technology Solutions business purchased from Avnet. TECD generated strong cash flow and reduced its long-term debt.

Sales will likely climb 18% during the next 12 months, after increasing 15% in the prior year. EPS will jump 25% to $10.10 after advancing 41% in the previous 12-month period. TECD shares sell at 12.2 times current EPS of $8.50, and the company maintains a solid balance sheet.

Tech Data’s market capitalization is $3.9 billion, which qualifies the company as a mid-cap stock. The company’s growth rate is high and the company’s P/E ratio is low, resulting in a very attractive PEG ratio of 0.87. I calculated the PEG ratio by first dividing the current stock price of 103.96 by the current earnings per share (EPS) of $8.50 to get the P/E. Then I divided the P/E by my forecast five-year earnings growth rate of 14% to attain the PEG ratio.

I expect TECD’s stock price to rise 30% to my sell target of 135.15 within 12 to 18 months. I recommend that you buy at the current price.

Until next time, be kind and friendly to everyone you meet.

Timothy Lutts

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