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Stockpickr: Top Stock Takeover Targets

James Altucher

Using the Stockpickr takeover targets system, we are able to find companies each month that are trading for less than seven times cash flows, making them ripe for acquisition. Those names then go into our system trades of the day portfolio.

The takeover targets system has historically returned 5.7% per trade and has not had a down year in the simulations we've run, in both bull and bear markets. We also update the takeover targets portfolio monthly so that the trades can be viewed for the entire month. The idea here is that when stocks get cheap enough, private-equity firms or other corporations will buy them for their cash flows -- even if the business is declining.

For instance, InterDigital Communications(IDCC Quote) is one of the companies on the list of takeover targets. Does your cell phone ring? If so, then you might be making use of a patent owned by InterDigital and licensed by your cell phone manufacturer.

Patent licensing is a business that results in very choppy revenue and cash flows. But don't worry about InterDigital; it has $300 million in cash in the bank, and it had $300 million in cash flows last year. Also, its recurring licensees have increased their payments to InterDigital by 32% year over year. The business is solid, and its core customers aren't going anywhere.

The King of Prussia, Pa., company has an enterprise value of $1.5 billion, and I wouldn't be surprised if a company such as Qualcomm (QCOM Quote) swept down on InterDigital and bought it for just six times cash flows. And I'm not the only one who thinks that way; InterDigital just maxed out its $200 million share-buyback program, extending it to $300 million.

Super-value mutual fund Heartland Value owns shares of InterDigital, as does hedge fund Renaissance Technologies. Renaissance is in line with my theory, as it continues to buy up companies that have a lot of cash, no debt and good cash flows. (As an aside, Heartland is one of my favorite value mutual funds to piggyback. It has returned an average of 15.7% over its 22-year history by focusing primarily on value-based micro-caps.) Other stocks owned by Heartland include Input/Output(IO Quote) and Skyworks Solutions(SWKS Quote).

Pioneer Drilling(PDC Quote) is another name on the takeover list. The company provides drilling services to oil and gas exploration companies. In other words, if you have a few million acres of land you'd like to drill to find oil or gas, you would hire Pioneer to come in and do the job. As long as people need oil, and as long as oil prices remain above $40, oil companies will be willing to spend more money to drill in places where it's harder to extract the oil.

Pioneer has a pristine balance sheet with $74 million in cash in the bank, giving it an enterprise value of just $522 million. I say "just" because the company's EBITDA (earnings before interest, taxes, depreciation, and amortization) is $176 million, meaning it trades at just three times cash flows. It has margins of 32%, and analysts expect revenue to be pretty much even next year compared with this year.

But Pioneer's business isn't really that important to us. In fact, it doesn't matter if its business gets cut in half, because right now it has an earnings yield of almost 33%. In other words, if its revenue and earnings remain the same, then for every $1 you spend to buy shares of this company, you get a return of 33 cents. This is a ludicrous amount and cannot be sustained.

One of two things is likely here: The company's business will decline, or the company will get acquired. Let's say you have $522 million to spend. You can either get 6% return in Treasury bills, or you can make 33% a year by buying Pioneer. OK, so that 33% is going to go down, but it doesn't matter -- you can get 10% on your money and you're still doing fine, particularly given the company's strong competitive position and clean balance sheet.

Surprisingly, Pioneer is a holding of the Bjurman Micro-Cap Growth Fund, run by Thomas Barry. I say "surprising" because the company doesn't seem like a growth pick. Other stocks held by Bjurman include Dynamic Materials(BOOM Quote) and Palomar Medical Technologies(PMTI Quote).

Stockpickr tip of the day: Here's a question for the ages: Who owns the Fed? Once I started reading the posts in this Stockpickr forum, I realized I didn't know the answer. If you can help figure it out, please post your response to the forum.