Investing advice: How we spot takeover candidates

We’ve been asked a number of times over the years about how we manage in our investing advice to recommend so many stocks that get taken over at a big profit.

Some readers, especially those of our Successful Investor newsletter, tell us that they never had a stock taken over at a profit until they began following our investing advice.

And some of these takeovers have generated big profits, indeed: Fording Canadian Coal jumped 163.2% in five months on a takeover offer after we recommended it to Successful Investor readers in January 2008.

Our investing advice also included a recommendation for Teranet Income Fund in August 2008. In one month, it rose 31% on a takeover bid. This was preceded by Sleeman, which gained 56.4% in five months before it accepted an all-cash takeover from Sapporo of Japan.

Another of our recommendations, Alcan, jumped 68.7% in just two months when Rio Tinto Ltd. made a successful takeover bid for the company after recognizing it had access to cheap electricity, a key component in aluminum production, at a time of rising energy prices.

Hidden value is the key

So how are we able to routinely spot takeover targets like these and include them in our investing advice? The answer is simple: we look for hidden value in the stocks we recommend, and that’s the same thing that corporate acquirers look for in takeovers (the Alcan takeover is a particularly good example of this).

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By hidden value, we mean valuable assets that are not getting the attention they deserve from investors. When a company’s assets are wholly or partially ignored or hidden, the stock trades for less than it’s really worth, so you get to buy at bargain prices.

Heads you win, tails you break even

Sometimes, of course, hidden assets stay hidden for a lengthy period. But our investing advice is that as long as a stock has more obvious appeal, such as long-term growth prospects, a reasonable per-share price-to-earnings ratio or an attractive dividend yield, you have what I’d call the best of all possible investment worlds: a heads-you-win, tails-you-break-even situation.

Moreover, if a stock with hidden assets gets cheap enough, it attracts buying by value-oriented investors. Its low price may also trigger a takeover that otherwise might never have happened. This tends to support the stock’s price if it runs into temporary difficulties.

If it works out well, it can be extraordinarily profitable; if it works out poorly, you really won’t lose that much.

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