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The global mergers and acquisitions market is picking up nicely in 2014. (Thinkstock)
The global mergers and acquisitions market is picking up nicely in 2014. (Thinkstock)


Three strong stocks that may be M&A targets Add to ...

John Reese is CEO of Validea.com and Validea Capital, and portfolio manager for the Omega Consensus funds. Globe Investor has a distribution agreement with Validea.ca, a premium Canadian stock screen service. Try it here.

The global mergers and acquisitions market is picking up nicely in 2014. In the first quarter, deal-making was up 54 per cent versus last year’s first quarter. With broader economic growth mediocre and more than $1-trillion (U.S.) sitting on corporate balance sheets, U.S. companies may continue to turn to M&A as a way to grow.

Morgan Stanley even recently offered a list of 44 multibillion-dollar companies that have a high likelihood of receiving at least one tender offer over the next 12 months. If these companies do make a deal, it could be good news for them and their investors over the long haul, as mergers create such benefits as economies of scale.

They can also be a big boost for shareholders in the short term, as the acquiring company pays a premium for the acquired firm. But be careful: Investing in a company simply because it’s a takeover target can be dangerous. Many of the rumoured targets end up not being acquired.

That’s why I think you should put potential takeover targets through the same fundamental scrutiny you would use on any other holdings. That way, you set yourself up for success even if a takeover doesn’t occur. And if it does happen, you may get an added bonus.

Mutual fund legend Peter Lynch – one of the gurus upon whom I base my investment strategies – said that when he benefited from takeovers, it wasn’t by design. “In spite of all the takeover rumours that fill the newspapers these days, I can’t think of a single example of a company that I bought in expectation of a takeover that was actually taken over,” Mr. Lynch wrote in One Up On Wall Street. “Usually what happens is that some company I own for its fundamental virtues gets taken over – and that, too, is a complete surprise.”

Still, there’s no reason you can’t use a takeover target list as a starting point. So, when I saw Morgan Stanley’s list, I ran the 44 stocks through my Guru Strategies to see which of them also had the fundamentals that I would want in any of my stock picks. While the vast majority of those on the list failed to make the grade, a few did have what it takes. Stocks like these have good potential, and if they are acquired, it could be a nice bonus. Here’s a look at a trio of them.

Neustar Inc.
This Virginia-based firm ($2-billion market cap) provides real-time information and analytics to the communications services, financial services, retail, and media and advertising sectors. It took a big hit early in 2014 after announcing guidance that fell short of expectations, but the model I base on the writings of hedge fund manager Joel Greenblatt thinks it’s a bargain. Mr. Greenblatt uses a remarkably simple strategy that looks at only two variables: return on capital and earnings yield, and he also takes metrics such as debt load into account. My Greenblatt-inspired model likes Neustar’s 11.6-per-cent earnings yield and 69.2-per-cent return on capital.

Aetna Inc.
This Hartford, Conn.-based health insurer has a $27-billion market cap and has taken in $47-billion in sales over the past 12 months. It gets high marks from my Lynch-based strategy. Mr. Lynch famously used the price-earnings-to-growth (PEG) ratio to find bargain-priced growth stocks, adjusting the “growth” portion of the equation for dividend yield for large, dividend-paying firms like Aetna. When we divide Aetna’s 13.7 P/E ratio by the sum of its long-term growth rate (12.9 per cent using an average of the three-, four- and five-year earnings-per-share growth rates) and dividend yield (1.2 per cent), we get a PEG of 0.97. That comes in under this model’s 1.0 upper limit. The Lynch-based model also likes Aetna’s 28 per cent equity/assets ratio and 4.2 per cent return on assets rate.

Ingredion Inc.
Based in Illinois, Ingredion ($5-billion market cap) provides ingredients to customers in more than 40 countries, across about 60 diverse sectors in food, beverage, brewing, pharmaceuticals and other industries. It specializes in nature-based sweeteners, starches and nutrition ingredients.

Ingredion is another favourite of my Lynch-based strategy, which likes its 38 per cent long-term EPS growth rate and 13.3 P/E ratio. That makes for a stellar 0.35 PEG ratio. The firm’s debt load is not insignificant, but its 75 per cent debt-equity ratio comes in under this model’s 80-per-cent threshold.

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