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Another Reason to be a Value Investor: Buyouts

Value investing provides the investor a wide variety of reasons to follow it as a general investing philosophy. In this article, I'm going to explore a potential advantage of value investing that is not always discussed: the heightened possibility of another company acquiring, or buying out, the stock of a value based investment. Then I'll examine several Magic Formula stocks that have been bought out this year, and would have provided investors in those companies a healthy return.

As Joel Greenblatt points out in The Little Book that Beats the Market, there are plenty of factors that can drive the stock of a cheaply valued company up. For one, it reaches the radar screen of value based investors once it gets low enough. Second, the company itself may find it's stock an attractive investment and put capital to work buying back shares and lowering the share count, which leads to price appreciation because each share earns a larger portion of profits. Third, and the point here, is that a competitor or private equity group could find the entire company attractive at the market price and decide to purchase it outright.

The best part about buyouts is that they are nearly always at a premium to the current market price of the company. This makes sense of course... investors would be unwilling to sell their shares unless they could realize an acceptable return on their investment. Often, the market value premium is significant. In 2006, the average premium was 29%, and in some past years that figure has been as high as 50%.

Cheap stocks are prime candidates for acquisition, and good companies at cheap prices are even better buyout bait. These are just the companies that the Magic Formula screen was designed to find. Sure enough, even in this weak environment for buyouts, several Magic Formula stocks have been acquired in 2008 (premium is against price while stock was on MFI screen):

TickerCompanyAcquirerBuyout Premium
EDSElectronic Data SystemsHewlett-Packard (HPQ)57%
FTDFTD GroupUnited Online (UNTD)16.5%
GYIGetty ImagesHellman & Friedman LLC36%
HIREHireRightU.S. Investigations Services LLC120%

Buyouts are a quick strike way to make a big profit, and they are most common amongst quality value stocks. Just another reason to consider making the Magic Formula Investing strategy your investing strategy.

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