Two Screening Strategies: Buyouts & Growth Stocks

By Yaser Anwar, CSC of Equity Investment Ideas

Simple Buyout Screen

-) Search for companies that generate enough cash from operations to pay an 8% interest rate on the debt needed to buy the company at today’s enterprise value (equity market value plus total debt outstanding minus cash on the balance sheet).

Look for for companies with steady cash flows, good balance sheets and a low valuation – exactly what value investors and buy out funds are looking for in making investments.

For example: A company with $100 million market cap and $10 million in debt would need to generate $8.8 million in cash from operations ($110 x 8% = $8.8 million interest expense) to take itself private.

This calculation doesn’t assume a premium needs to be paid for the stock, that no equity needs to be injected into the deal (just straight debt), and I make no tax adjustment for the additional interest expense that the company can write off on their bill to Uncle Sam. Nor do I base my numbers on forward estimates just on the TTM numbers.

Mid/Small-Cap Growth Screen

1) Focus on stocks with market values below $250 million.

2) Look for companies that will attract more attention from investors over time as their business and profitability improves.

3) Give the stock two-to-five years to reach a market cap of $500 million to $600 million, the range where a winning stock is typically sold. Also, look for companies hitting new highs and profit margins should be expanding

4) Diversification is key to the investment strategy. So no one position should reflect more than about 1.5% of the portfolio.

You’ll notice, a lot of companies in this space tend to have few products or services. Some will fall hard; some won’t do a lot, and a few will help you out and make a lot of money. The best thing you can do is diversify.

5) Strong Balance sheet is must. Look for cash to be at least two to three times the debt (preferably low debt). Look for businesses that have good brand recognition and diversified earnings exposure (not just one company buying their services. i.e. Avici Systems)

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