In my last article, I screened for turnaround stocks, those that had high Value and Momentum Ranks. Several of the screen results were subject to takeover offers. This may mean that cheap stocks where trading momentum has turned positive are attractive to acquirers. However, we need a much larger sample size than three to say that for definite since it is also possible that the takeover is the source of the positive change in price momentum. It may be an outcome rather than a cause. For example, TI Fluid Systems (LON:TIFS) had a decent StockRank prior to receiving an offer, but Momentum was its lowest component. Whether it is cause or effect, investors in turnaround stocks need to be prepared for the odd takeover offer.
When faced with an investment opportunity, investors typically use investment ratios to help assess its suitability. For example, Quality investors may look at long-term returns on capital or equity, Value investors may use P/E ratios, and Momentum investors may examine recent price changes. Most investors will look at all of these factors and many more. The Stockopedia StockRanks take many of these metrics and combine them to give a single measure, which may also be helpful. Investors should be wary of oversimplification, but when applied consistently, these metrics can give investors a significant advantage in their pursuit of beating the market.
However, once a company has received a takeover offer, either a firm offer or a possible one, the previously wide field of potential long-term outcomes typically narrows to a much smaller subset of short-term outcomes. The usual metrics are no longer particularly useful for identifying whether an investor should continue to hold such a stock. At this point, a different skill set is required to analyse the investment case. When I looked at National World (LON:NWOR) as one of the turnarounds, I said:
This makes it a special situation, and investors need to take a probabilistic approach to the various outcomes rather than pure valuation metrics.
In this article, I will describe how that approach may be undertaken.
Scenario planning
The key first step is to list all the potential outcomes. Prior to the subsequent news of an improved but "final possible offer" from Media Concierge, here was what I thought the possible outcomes were. (See the original article for a summary of how the company ended up in…
