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Professor Aswath Damodaran's Target Company M&A Screen
Posted by: Mark Lin (IP Logged)
Date: November 9, 2012 11:52AM
Aswath Damodaran is a professor of finance at NYU Stern. He is the author of several widely used academic and practitioner texts on valuation, corporate finance and investment management, and is regarded as an authority on the subject of valuation.
He has also written books about investing, notably "Investment Philosophies and Investment Fables." In Chapter 10 of "Investment Fables: Exposing the Myths of 'Can't Miss' Investment Strategies," he talked about how, if one could identify target firms before they become targets in acquisitions, one would be able to reap incredible rewards.
He found characteristics of companies more likely to be acquired:
- Poorly managed companies are more likely to bought over as there is room for improvement and a chance for acquirers to "make a good company great."
- Managers who are not entrenched are in a weaker position to resist change of control.
In addition, he suggested low-risk stocks, so that even if a merger or acquisition (M&A) does not materialize, the downside risk is not magnified.
He suggested the following criteria to screen for stocks likely to be targets in M&A:
- Return on equity more than 4% below the peer group ROE (to be modified)
- Stock returns over last year lag peer group returns by more than 5% (to be modified)
- Annualized standard deviation in stock prices exceeds 80% (to be modified)
- Insider holdings less than 10%
- debt to capital ratios< 50%
I have modified the first three criteria slightly and the new screening criteria is as follows:
- Return on equity (trailing twelve months) less than half of return on equity (five-year average)
- Current P/B less than 70% of five-year average P/B
- Beta< 1.5
- Insider holdings less than 10%
- Debt to capital ratios< 50%
The following stocks passed the Damodaran Target Company M&A Screen:
All the stocks had zero debt.
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