Stockpickr: The Top Takeover Target Stocks

The main goal of Stockpickr is to boost your trading performance, and to that end we've created a new feature called System Trades of the Day. We've backtested several trading systems that have resulted in significant and consistent gains during the past five to 10 years during bull markets, choppy markets and bear markets.

Some of these systems are fundamentally based, like our Takeover Targets System. Other systems are based more on price action, like our 3x2 System, our Mega-Gap System, and our QQQQ Sweet Spot, which is a system for shorting the Nasdaq 100 Trust(QQQQ Quote).

Each day, we put a collection of stocks in the System Trades portfolio that have triggered for that day and also have had the most success in the past.

The Takeover Targets System rebalances every month, meaning that it comes up with a new set of stocks that are most likely to be buyout candidates. In January, Houston Exploration(THX Quote) was on the list and was bought out early in the month.

Here's the basic idea: If a company trades at a low multiple over cash flows, then it's worthwhile for other companies or investors to take on debt, buy the company and use the cash flows to pay down the debt. Essentially, they are buying the company for free once the debt is paid off.

For example, let's say company XYZ is worth $1 billion but has $100 million a year in cash flows. If interest rates are 6% and if you believe XYZ's earnings will grow, or at least remain stable, then it could potentially make sense to borrow $1 billion and buy XYZ. Then, with the $100 million in cash flows, you'd pay back the $60 million in interest payments, plus throw in some amount each year to pay down the debt.

The Takeover Targets System looks for all companies that are trading for less than seven times trailing cash flows and buys them on the first day of each month, holding them for a month. There are other criteria, based on market cap and debt levels, that are included in the system as well. Check out the Takeover Targets System here.

How has the system done? We tested it from 2000 to mid-2006 and it has performed very well. In the chart below, we simulated the results using only 2% of equity per trade. For different results, you can use 5%-10% of equity per trade, or more. However, the important part is that each year was up, in both bull and bear markets.

Stockpickr: Takeover Targets System

Source: Stockpickr

Additionally, the average return per trade was 5.73%. In 360 occurrences, 60% of the trades were profitable.