My balance-sheet-based approach to stock picking has the benefit of regularly uncovering investment opportunities that are also potential takeover targets. This is particularly the case when companies are being valued on large discounts to book value even though there are few signs of any financial distress. Rest assured, if my analysis highlights that a company is being miserly rated well below the current value of its assets, and potentially on a far deeper discount to their replacement value, then predators with deep pockets will be doing the same exercise, too.
The catalyst for a bidder to pounce and take advantage of the valuation anomaly on offer is more often than not an improvement in underlying trading in the target company which mitigates the investment risk for the acquirer even further. Hence, my approach is to seek out good-quality companies underpinned by sound balance sheets where there is potential for an earnings recovery, or ongoing earnings momentum to continue, but where I can pick up the assets below book value. The rewards can be mightily impressive, too, as readers who followed my advice to buy into Aim-traded sweet manufacturer Zetar (ZTR), which received a bid only a few weeks ago, will testify ('A sweet investment', 8 October 2012).
This approach to investing also explains why my annual Bargain Shares portfolios, which are based on the writings of the grandfather of value investing Benjamin Graham in his classic book, The Intelligent Investor, have been littered with companies that have subsequently succumbed to takeover bids. To name but a few, these have included housebuilders Ben Bailey and Crest Nicholson; computer components distributor Fayrewood; recruitment company Quantica; industrial group Delta; and clothing retailer Jacques Vert.
