Manager David Wallack says energy, health care still offer opportunities.
Despite a strong move last year, mid-cap stocks still have more breathing room than other corners of the market, according to David Wallack, manager of T. Rowe Price's Mid-Cap Value Fund. But opportunities are not as abundant as they were two years ago.
"I can't say that this is the optimal moment to plunge into mid-cap stocks," says Wallack. "But their valuations are still 5% to 10% below the medians for larger companies. And there are still some good opportunities in sectors such as energy and health care."
Wallack says he doesn't feel penned in by the narrowing valuation gap between growth and value stocks, either. As long as hard times befall companies, industries fall out of favor and investors scramble for the sidelines, the 43-year-old manager will have fodder for new investment ideas. To get stocks at rock-bottom prices he begins buying them when other investors are bailing out, and selling as others are piling in. "What we're after are medium-sized, well-established companies at a transition period in their lives," he says. "I'm looking at where a company will be several years from now."
With that vision in mind Wallack recently added to the fund's position in Tenet Healthcare, the country's second-largest hospital management company. Many investors remain concerned about litigation related to patient overcharges, declining earnings and cash flow, and demands for price concessions from managed care chains. But Wallack believes those problems are not insurmountable.
"It's going to take some time to work through these issues," he says. "But things are getting better. The company is divesting its worst-performing hospitals, lowering its cost structure, resolving litigation issues, and trying to negotiate better terms with HMOs. And the stock is cheap." Wallack says that the "reconstituted" company has the potential to trade at $20 to $25 a share, significantly higher than its current price of around $12.
Another recent addition is the biotechnology company Medimmune, a new position Wallack established after the stock declined following the company's announcement of problems with its FluMist launch. He thinks the vaccine will ultimately create value for the company this year.
On the other hand, some sectors that contributed to last year's solid fund performance have gotten too expensive for his taste. "A year or two ago we had some great buying opportunities in technology companies," he says. "These days, tech bargains are few and far between. We haven't added much in this area recently." Financial stocks-at 17% of assets his largest sector bet-have also move beyond his comfort range. "We're not finding much to buy, except for a few regional banks and property and casualty insurers," he says.
Looking For A Catalyst
Although he is willing to wait out bad times, Wallack has to see some catalyst for a turnaround down the road. That catalyst could be financial flexibility to invest in new products and acquire companies. It could be a clear path to cash flow, such as the ability to divest assets or slash costs. Or, it could take the form of a hidden asset, such as a bulging portfolio of valuable real estate or securities. In addition to such catalysts, he likes to see companies that have a dominant market position, managers with the experience to pick a company up by its bootstraps, debt that totals no more than 30% of capitalization and industries with high barriers to entry.
And, of course the stocks must be bargains. By measures such as price-to-book, price-to-sales and price-to-cash-flow, holdings are slightly less expensive relative to other funds in Morningstar's mid-cap value category and downright cheap compared with the S&P 500 Index. The fund often focuses on smaller mid-cap stocks than its peers, a bias that worked in its favor last year as smaller names excelled. The average market capitalization of its holdings is $3.8 billion.