How to Buy a Stock That Is a Buyout Candidate?
- 1). Identify the right industries. Stocks of companies that are producing out-of-date products, such as manual typewriters, are low priced because their industries are dying. There is a difference between low-priced and undervalued.
- 2). Look for companies with market capitalizations (which equals number of shares outstanding times stock price) from $100 million to $1 billion. This puts them in the small to mid-cap company sector, which is where the buyout activity happens.
- 3). Select only the profitable companies with a stock-price-to-cash-flow ratio of 3 or lower (divide stock price by cash flow), which means that the stock is selling at a price that is three times cash flow per share. Buyouts usually offer a higher price than the stock is selling for in order to encourage the shareholders to tender their shares, so you want a stock that is currently trading at a bargain price.
- 4). Refine your list to companies with a debt to equity ratio of 0.5 or lower (divide total debt by total stockholders' equity) to find companies that have a conservative amount of debt on their balance sheets. Acquiring companies often issue debt to cover the cost of their stock bid. This is called a leveraged buyout because the equity value of the target is leveraged to fund the buyout.
- 5). Research the companies on your list to find out why they are trading inexpensively. Use the company reports available from MSN Money, Yahoo! Finance, or an online broker. TD Ameritade and Charles Schwab each have good company research tools.
