Two trillion dollars worth of merger activity has been announced so far this year -- and it's July.
With all the mergers going on, investors are no doubt wondering if their stocks will soon be acquired for a nice premium.
C'mon, big money!
Recent merger mania seems to be focused on two major trends: industry consolidation, with larger firms like Walgreen
Shareholders of the acquired company typically receive some nice premiums, and this has been particularly true of late. Option Care shares shot up nearly 25% when the Walgreen deal was announced. Hilton shareholders saw a 26% jump on the next trading day after the Blackstone deal hit the newswires after hours on July 3. In fact, the weight of the Hilton deal was so great that it also lifted the shares of other large hoteliers such as Starwood Hotels & Resorts
Sounds great, right?
Hey, no one's going to complain about a quick 26% gain, but for small-cap investors there may be a dark cloud over many of these deals.
Because small caps have huge growth potential, a public or private buyout may cut off what could have been a portfolio- (and perhaps life-) changing stock.
Consider: What if MEMC Electronic Materials
Chuck Royce, manager of the Royce Premier Fund (RYPRX), summed up this sentiment nicely in a recent interview:
If a company is taken private at a 15% to 20% premium, it looks like a great short-term benefit. But it gives pause to small-cap investors like us, who employ a fundamentally driven, business-buyer's approach and often own companies for five to 10 years, if not longer.
Wise words from the man who has steered the Royce Premier Fund to 14% annualized returns over the past decade.
Between a rock and a hard place
Private equity buyouts and mergers are an integral part of small-cap investing, and let's face it, the next small-cap buyout is coming soon -- big money is finding a ton of value in small companies. But that doesn't mean you should go out and try to pick the next buyout.
As a small-cap investor, all you can do is continue to look for financially stable, well-run companies. If you can find value in promising small caps, a buyout would just prove your thesis right. As for where to look, follow Chuck Royce's three precepts:
- Focus on small companies.
- Employ a fundamentally driven, business-buyer's approach to small-cap investing.
- Plan on holding for five to 10 years, if not longer.
And mix those with three learnings from Motley Fool Hidden Gems, where Tom Gardner and Bill Mann have had seven companies from their scorecard acquired (and two more in the process of being acquired):
- Hunt for cash-rich balance sheets.
- Look for top-flight managers (who preferably have an ownership stake in the company).
- Buy businesses with a wide market opportunity or a valuable product roster.
We employ these principles at Motley Fool Hidden Gems with good results thus far: Our picks are beating the market by 37 percentage points since our inception four years ago. If you'd like to see the companies we've selected for subscribers, a trial is free for 30 days. Simply follow this link to get started.
This article was originally published on June 12, 2007. It has been updated.
Todd Wenning is firmly convinced that Guitar Hero is the greatest video game ever made. He does not own shares of any company mentioned. Royce Premier is a Champion Funds selection. The Fool's disclosure policy is never for sale.