3 Mid-Cap Stocks to Buy to Beat the Market

The stock market is stuck in neutral, but here are 3 under-the-radar stocks that should generate significant alpha

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The stock market rocketed higher after Donald Trump won the 2016 Presidential Election. Promises of a pro-business-growth era supported a rally across most sectors of the market.

But that rally has come to an abrupt end, and markets have been in neutral for some time.

The S&P 500 index is down about a percent over the past month, while the Dow Jones Industrial Average is down about 1.5%.

With stocks stuck in neutral, it is becoming increasingly important to separate potential winners from potential losers. After all, when picking stocks, what truly matters is producing above-market returns.

Here are three mid-cap stocks that I think will do just that, in both the near- and long-term.

Mid-Cap Stocks to Buy: e.l.f. Beauty Inc (ELF)

Mid-Cap Stocks to Buy: e.l.f. Beauty Inc (ELF)

My first pick on this list is the cosmetics company, e.l.f. Beauty Inc (NYSE:ELF). At first glance, ELF stock is a pure-play on the secular trends pushing the cosmetic industry higher. Those tailwinds propping up personal care spending are very strong. Think the athleisure wave and the rise of juice bars and health-conscious eating habits.

Also think about the emergence of “Selfie” apps like Instagram, owned by Facebook Inc (NASDAQ:FB) and Snap Inc’s (NYSE:SNAP) signature Snapchat app. ELF and beauty products fit in perfectly with the whole look-good, feel-good trend Millennials have broadly adopted.

ELF, though, is much more than just a pure-play on the rise in personal care spending. The company is the leading discount player in the industry, offering similar quality products at significant discounts to industry standard prices. This has led some analysts to label e.l.f. Beauty as the “fast fashion of beauty“. In many ways, ELF is following in the footsteps of H&M and Forever 21. Those fast fashion retailers soared in popularity a few years ago, and it looks like e.l.f. Beauty is at the beginning stages of what could be a very similar uptrend in market share.

The discounting factor is especially important considering ELF’s target “Selfie generation” audience. The company is actually doing a lot of things right to fully capitalize on the “Selfie generation”. As opposed to relying of celebrity endorsement to push product, e.l.f. Beauty is leveraging the Selfie generation trends of social sharing to push product through consumer-centric channels like Instagram and Snapchat. ELF’s employee base (80% women, 71% millennials) also speaks to the fact that the company is in touch with its target demographic.

The market seems to be keen on giving this stock a premium multiple into the foreseeable future. Secondary offerings usually drop stocks due to dilution. ELF stock, however, traded markedly higher on news of the secondary offering. That tells me there is a lot of demand out there for e.l.f. Beauty stock.

And why shouldn’t there be? Sales are expected to grow some 26% this year to $290 million, and the pathway to a $1 billion brand has a ton of visibility given the aforementioned secular tailwinds. Gross margins are expanding healthily due to a more favorable product mix, and management thinks there is upwards of another 100 basis points of expansion there by 2019. At the bottom-line, I agree with the Street that this is a company that can grow earnings at a 20%-plus compounded rate over the next 5 years.

That sort of growth is tough to find, and I think ELF is one of the best mid-cap stocks to buy on a dip.

Mid-Cap Stocks to Buy: Axon Enterprise Inc (TASR)

Mid-Cap Stocks to Buy: Axon Enterprise Inc (TASR)

My second pick on this list is much different than my first, but is also a play on secular tailwinds. Axon Enterprise Inc (NASDAQ:TASR) sells a suite of technologically enhanced products to law enforcement agencies globally. The main suite of products currently includes smart weapons, body cameras and a cloud-hosted video management system.

A notable uptick in police-related shootings, as well as an uptick in press coverage of them, has somewhat forced the hand of law enforcement agencies to increase their transparency with the public. As a result, Axon (formerly known as Taser International) has been selling a lot of body cameras recently. Sales were up more than 40% year-over-year in each of the last two quarters.

But the company is making a huge bet on its already burgeoning body-camera segment. In hopes of rushing the body camera adoption cycle, Axon is giving away free body cameras to every police officer in the U.S. for one year.

As mentioned earlier, the company changed its name from Taser International to Axon Enterprise, and will start trading under the ticker AAXN. Its a big change, and the market’s gut reaction was quite negative. Giveaways, after all, weigh on financial performance, and Axon’s margins are already under pressure.

I think this is a perfect buy-the-dip opportunity that will generate significant alpha for the patient investor. Yes, earnings are pretty much wiped out for this year, but this is a growth company with a pathway to a billion dollar annual run-rate business. The timeline to that billion dollar annual rate just became significantly shorter.

Financially, the company will take it in the shorts for the next 12 months, but the outlook thereafter is extremely promising. At the end of the fourth quarter, only 35 of the 68 major city law enforcement agencies had purchased an Axon product. That means Axon has penetrated about half the domestic market. This one-year free trial will undoubtedly hasten the pace at which the other 33 agencies adopt Axon’s products.

Those annually recurring revenue streams will start coming online next year. Those revenue streams will be accompanied by brand new high-margin revenue streams from Axon Fleet (dash cameras that just started rolling out) and Axon AI (an AI product that will focus on gleaning actionable insights from video data, is set for a late 2017 launch), so fiscal 2018 is shaping up to be a monster year.

In context of other subscription businesses, this is very much like a one-year free trial. All successful subscription-based businesses offer free trials. Amazon.com, Inc. (NASDAQ:AMZN) offers a free 30-day trial for its Amazon Prime service. Netflix, Inc. (NASDAQ:NFLX) offers a free month trial as well. I think Axon will be equally successful with its free trial offering.

All in all, this feels like a bottom for Axon given the negative sentiment surrounding the critical business pivot. The stock could be shaky over the next several months, but long-term, the upside potential is very promising. Fiscal 2018 is shaping up to be a monstrous growth year, and its always good to get in before the growth materializes.

Mid-Cap Stocks to Buy: Ross Stores, Inc. (ROST)

Mid-Cap Stocks to Buy: Ross Stores, Inc. (ROST)

Retail has been in the dog house recently. Across the board, retailers are positing negative same-store sales, closing stores and experiencing earnings compression.

As a result, a lot of retail names have missed out on the stock market’s recent rally. While the S&P 500 is up more than 5% year-to-date and almost 14% over the last year, the SPDR S&P Retail (ETF) (NYSEARCA:XRT) is down about 6.5% year-to-date and more than 10.5% over the past year.

But not all retail names are struggling. One company bucking the broad retail demise is discount retailer Ross Stores, Inc. (NASDAQ:ROST). Last quarter, Ross Stores saw comps rise 4%, on top of a 4% increase last year. For the full year, sales rose 8%, operating margins expanded to a record 14%, and earnings-per-share grew 13%. ROST is also opening stores, contrary to the store-closing trends in retail today, and expects to open 90 new stores in 2017.

The opportunity here is that ROST stock has sold-off with the broader retail segment recently despite the company’s sustained out-performance of the industry. ROST stock is down about 5% over the past month, weighed down in part by a poor sales update from Urban Outfitters, Inc. (NASDAQ:URBN) and continued negative sentiment surrounding L Brands Inc (NYSE:LB).

Ross Stores, however, has proven that its performance is largely unrelated to broader retail trends. In the era of Amazon.com, Inc. (NASDAQ:AMZN) and price-focused consumers, discount retailers like ROST are winning.

From this perspective, the recent dip in ROST stock should be bought. The valuation is reasonable at 18.5-times forward earnings for 10.4% growth over the next two years. The 22.5-times trailing earnings multiple is a relative valuation trough and well-off its late-2016 highs of 25.5-times. ROST also continues to hike its dividend, buyback shares and grow its cash balance.

Overall, ROST stock has strong long-term fundamentals, which support significant market out-performance from these relatively depressed levels.

As of this writing, Luke Lango did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, https://investorplace.com/2017/04/3-mid-cap-stocks-to-buy-to-beat-the-market/.

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