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How to
Spot Buyout Candidates
Last week, Charlotte Russe shareholders enjoyed a sweet 27% share price
pop after the teen clothing retailer agreed to be acquired by a buyout
firm. In July, personal finance website operator Bankrate also scored a
double-digit gain on a takeover offer.
Those deals signal that the takeover market might be coming to life
again, creating an opportunity for astute investors.
Charlotte Russe and Bankrate were both relatively small, cash rich,
reasonably valued, no-debt companies that were in favor with the smart
money. Here’s how you can use MSN Money’s free Deluxe Stock Screener to
find similar stocks.
Find the screener from MSN Money’s homepage (moneycentral.msn.com)
by selecting
Investing and then
Stock Screener. If you’re a first-time user, you’ll have to download
free special software (requires Internet Explorer).
You may need to spend some time learning how to use the screener,
but it’s worth the effort. Locating the
suggested screening factors can be tricky, so I’ve included the category
where you’ll find each specified factor in parenthesis.
Not Too Big
Since borrowing is difficult, buyout firms are focusing on relatively
small firms. Market capitalization is how much cash you’d have to pay to
buy all of a firm’s shares. Charlotte Russe and Bankrate’s market-caps
were in the $300 million to $500 million range. I set my maximum
allowable market-cap (Company Basics) at $500 million. Since the smaller
the company, the higher the risk, I also specified a $250 million
minimum allowable market-cap.
No-Debt
As mentioned, neither acquired firm carried any debt. The debt/equity
ratio compares debt to shareholders equity (book value). A zero ratio
means no debt and the higher the ratio, the higher the debt. Rather than
zero, I specified a maximum 0.1 D/E ratio (Financial Condition) to allow
companies carrying incidental debt (e.g. long-term leases).
To avoid cash poor firms, I also required a minimum quick ratio of 1
(Financial Condition), which means that ready cash (cash on hand plus
receivables) must at least equal current liabilities.
Making Cash
Cash flow measures the cash that flowed into or out of a firm’s bank
accounts from its opertions. Some firms report earnings, but aren’t
really profitable when you count the cash. Both Charlotte Russe and
Bankrate were cash flow positive, meaning that cash was flowing in, not
out. Requiring a positive price/cash flow ratio (share price divided by
12-month’s cash flow) assures that passing stocks meet that requirement.
Thus, I set my minimum allowable price/cash flow ratio (Valuation) at 1.
Private equity investors also use the price/cash flow ratio to measure
valuation. The ratios for both acquired firms were below 20. I set my
maximum allowable price/cash flow ratio at 20.
Profitable
Buyout firms want profitable companies. Return on equity (net income
divided by book value) is a widely used profitability gauge. Any
positive value signals a profitable company and the higher the number,
the better. Since many usually profitable firms chalked up negative
numbers this year, I use the five-year average ROE (Investment Return)
and require a minimum value of 5.
Smart Money Knows
Institutional ownership is the percentage of a firm’s outstanding shares
held by institutional buyers such as mutual funds. It typically ranges
from 40% on up for most stocks. However, both Charlotte Russe and
Bankrate had more than 95% institutional ownership signaling that these
savvy players may have suspected that something was afoot. Thus, I
required a minimum 95% institutional ownership (Trading & Volume).
My screen turned up five potential buyout candidates: Haynes
International (HAYN), Hot Topic
(HOTT), K Swiss (KSWS), Matrix Service
(MTRX), and Zoll Medical (ZOLL).
Here's a
link if you want to see what the screen turns up today. Only
time will tell how accurate I was at predicting takeovers. Do your due
diligence. Only buy stocks that look like good investments, even if
they’re not acquired.
published 8/30/09 |
