How To Make Money From Mergers And Acquisitions: Part Two

In last Monday’s column, I discussed why owning a company that gets acquired can be extremely lucrative. Today, I’ll talk about how to increase your odds of owning one of these takeover candidates.

You should never buy a stock only because you think the company will be acquired. The company should have some other redeeming qualities. Fortunately, most companies that do get acquired are bought because they are strong businesses or because they have a product or service that is needed by the acquiring company.

That makes perfect sense. As investors, we can get lost in the world of stocks, but stocks represent ownership stakes in businesses. And if a business is going to get bought, it’s likely because it’s a successful one.

Forget about stocks for a minute. Imagine you were going to buy a business, maybe a restaurant. What would make one diner more appealing to buy than another? There are a few things you’d probably look for.

  • Rising sales. Unless the business is a turnaround situation, you usually want to buy one that is growing. If you’re choosing between two restaurants to buy, one of which has flat sales and the other of which is growing, you’re likely to be more interested in the one with rising sales.
  • Attractive valuation. When buying a business, you don’t want to overpay. A business with growing sales will likely be priced higher than one with flat or declining sales, but that doesn’t mean the higher-priced business is not an attractive value. There are various valuation metrics that take growth into account. A shrewd buyer will not pay too much for a business or company.
  • Low debt. If you were buying a business, you’d prefer to buy one with low debt. Who wants to be the new owner of a business and be on the hook for huge interest payments?

Keep in mind, not all acquisitions will match all three of these metrics. After a 10-year bull market, it can be tough to find stocks trading at a low valuation. If the valuation is a bargain, there may be a good reason that the business is cheap.

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