If it seems like there’s been a lot of M&A activity this year, you’ve clearly been paying attention.
With three full weeks still to go, 2015 has already set a record for mergers and acquisitions. Companies spent $4.304 trillion on mergers this year, eclipsing the previous record of $4.296 trillion set in 2007. All that M&A activity means a number of things: large companies are flush with cash and willing to spend it; the global marketplace is shrinking to the point where only the truly strong survive; and the economy is healthier than at any point since the recession.
What the record M&A activity also means is that that are a lot of small-to-medium-sized companies (and even large companies) out there that are being gobbled up, and it pays to be a shareholder in one of them when it does.
Big Buyouts = Big Returns
Just look at the returns from a few public companies that were on the buying end of some of this year’s largest acquisitions:
Allergan (AGN) (A Cabot Benjamin Graham Value Investor stock)
- Bought by Pfizer (PFE) in November for a near-record $160 billion
- Rumors of the deal began swirling October 28
- Stock gain in the six weeks since: 9.2%
Time Warner Cable (TWC)
- Bought by Charter Communications (CHTR) for $79.6 billion in May
- Stock gain in the six-plus months since: 17.3%
- Bought by Anheuser-Busch In-Bev (BUD) for $104 billion on October 13
- Rumors of the deal trickled out on September 16
- Stock gain in the nearly three months since: 30%
Not all acquired companies get the same kind of bump. EMC Corp. (EMC), for instance, is basically flat since Dell (DELL) bought it for $67 billion in October. But by and large, mergers and acquisitions work out well for the companies—more specifically, the stocks of the companies that were bought.
That’s why it makes sense to have a few takeover candidates in your long-term portfolio: getting bought out can net an awfully big return in very little time. Of course, that’s nothing new. Investing in takeover candidates before they’ve been taken over has long been common practice among savvy investors. The difficulty is, as it always has been, determining which companies are buyout candidates.
Common Characteristics of Buyouts
That’s far from an exact science. But to get a sense for the type of company that’s being bought out amid record M&A activity, let’s examine some of the common characteristics the recent high-profile buyouts shared.
1 Growing revenues. Every takeover stock mentioned above has been growing revenues for at least the last two years. Just like you wouldn’t want to invest in a company with declining sales, major corporations do not want to take on smaller companies with sinking revenues.
2. Healthcare and technology. These two sectors have led the M&A charge this year. Headlined by the Pfizer-Allergan deal, healthcare companies have accounted for 15.4% of the M&A activity in 2015, more than any other industry. The technology sector (Time Warner, EMC Corp., etc.) is a close second, accounting for 13.5% of the total volume.
3. Little debt. No one wants to take on debt, not even the largest companies in the world. So the best takeover candidates generally have small debt-to-equity ratios. Allergan’s debt was 34% at the time Pfizer bought them; EMC Corp.’s was 16%; and SABMiller’s was a mere 13%. Anything above 30% is pushing it … but not for a company as large as Pfizer.
Those are the main traits to look for when seeking out takeover candidates—to get more specific than that would be little more than pure speculation. Even big institutional investors don’t really know which companies are ripe for a takeover—otherwise they would go all in on them long before rumors about the deals were splashed across the front page of The Wall Street Journal.
And as we’ve seen from this year’s biggest mergers, takeover targets come in all shapes and sizes. Small and mid-caps are the best places to look; but the four companies mentioned above were all very large, with market caps of more than $45 billion at the time they were bought.
Possible Takeover Candidates
Going strictly by the rumor mill, two companies to keep an eye on as possible takeover targets are Abercrombie & Fitch (ANF) and Barnes & Noble (BKS). Abercrombie has been considered a buyout target ever since embattled CEO Mike Jeffries resigned last December; Barnes & Noble, the lone remaining publicly traded national book chain, always seems ripe for a takeover despite slipping revenues.
After a record year for M&A activity, there are sure to be plenty of deals still to come in 2016 and beyond. If you own a stock that’s on the buying end of one of those deals, it’s a good way to make a quick gain.