Tocqueville's Select Fund Reveals Mid-Cap Value

By Will Ashworth | March 09, 2011 AAA

The S&P Midcap 400 has increased 133% since its five-year low in March 2009. Stocks aren't nearly as cheap as they were two years ago. This doesn't mean there aren't any values, just that you have to look farther afield. Originally, I was going to use the top ideas from the $1.1 billion Delafield Fund (DEFIX) to find some mid-cap winners because it has an excellent track record with minimal turnover. However, while perusing Tocqueville Funds' website, I came across the Select Fund (DESYX) - a much smaller fund ($55 million) managed by Dennis Delafield and Vincent Sellecchia, the same two managers as the Delafield Fund. The turnover is approximately the same with a much smaller, focused group of holdings. I'll pick the best stock to own from its top positions.
IN PICTURES: 5 Tips To Reading The Balance Sheet

Tocqueville's Select Fund - Top Holdings

Company Market Cap % of Total Assets
Sonoco Products (NYSE:SON) $3.69B 4.09%
Flextronics (Nasdaq:FLEX) $5.91B 3.81%
Kennametal (NYSE:KMT) $3.12B 3.71%
Owens-Illinois (NYSE:OI) $4.88B 3.45%

And Then There Were Four
The first thing you should know about the table above is that I didn't simply take the top holdings from the fund's most recent reporting period. That's because among the top 10 positions were several small caps including Collective Brands (NYSE:PSS), the fund's top holding at 5.17% of the total assets. With brands like Sperry Top-Sider, Keds, Saucony as well as Payless Shoe Source, it's a good company. Unfortunately, for the purposes of this article, I'm looking for mid-caps. However, if you're interested in smaller stocks Collective Brands is definitely worth your attention. Secondly, I've only included four stocks in the table because those were the only mid-caps in the fund's top 10 holdings. In many respects, it's just as accurate to describe it as an all-cap fund because it also owns a large-cap in Ingersoll-Rand (NYSE:IR) and a small cap in Summer Infant (Nasdaq:SUMR). It's an interesting group of holdings for sure.

Financial Health
I like to see current assets that are twice current liabilities and total debt that is less than EBITDA. It provides a greater margin of safety than total-debt to equity. Kennametal has the best financial health with a current ratio over two as well as EBITDA earnings that are greater than total debt. It's the only one of the four to meet both criteria. Owens-Illinois, on the other hand, has the worst financial health with total debt 3.6 times EBITDA. However, its current ratio isn't terrible and this could be one of the reasons why the Select Fund owns the manufacturer of glass bottles.

In this section, I've compared their five-year compound annual growth rates for revenue as well as the cumulative five-year growth in operating cash flow. If it's not growing sales, at least it should be growing cash from operations. In terms of revenue growth, Flextronics tops the charts with 8.7% annualized growth over the past five years. Kennametal lags the rest of the field with negative 3.9% growth. However, despite suffering significant revenue and earnings declines the last two years, it continued to invest in its business. If the last two quarters are any indication, its financial performance will be back to pre-recession numbers very soon.

My first task is to identify which stocks are trading significantly below their five-year highs. Owens-Illinois, Flextronics, Sonoco Products and Kennametal are respectively trading 50.7%, 42.4%, 20.0% and 17.1% off their 5-year highs. Value investors look to buy good companies at discount prices and while none of these are bargain basement, they certainly aren't expensive. Based solely on valuation, Flextronics and Owens-Illinois are the clear favorites here. A side-by-side comparison of enterprise value to EBITDA produces a winner in Flextronics, which trades at just 5.9 times EBITDA compared to 7.2 for Owens-Illinois. This will certainly weigh heavily in my overall decision.

Bottom Line
I have two recommendations. Conservative investors go with Kennametal because of its superior balance sheet. However, if you're more enterprising, I'd go with Flextronics because of its potential growth and 40% discount to the S&P 500. (Buying value stocks that are moving higher helps investors steer clear of value traps. Check out Value Investing + Relative Strength = Higher Returns.)

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