Open Book: Pick Stocks Like an Activist Investor

In many situations, activists, like those investing in Brinks, identify companies that they believe hold too many disparate businesses under one roof with limited strategic connections. Having too many different units makes it difficult for outside observers to accurately value each subdivision. In such circumstances, an activist can easily come along, analyze each division and decide that the company is worth more to shareholders divided and sold into separate units rather than kept together as a whole. Under pressure, Brinks in 2006 already sold one division for $1.1 billion.

As a group, activists have, for the past decade or so, inhabited the U.S. and almost nowhere else, with the exception of a few insurgents dabbling in Europe. Only recently has the strategy exploded in size and number -- about 100 activists collectively direct about $150 billion in assets, and many insurgents oversee billions in AUM. In the 1990s, the vast majority of activists could best be described as small-time gadfly investors that would agitate for change at companies with significantly less than $100 million market capitalizations . Today, these same managers and many others have significantly more capital behind them, and they target small , medium and large companies. Many managers are now effecting change at large beasts, such as Home Depot. (HD Quote), Motorola (MOT Quote) and ABN Amro (ABN Quote), each employing a wide variety of tactics.

They also have transformed in another way: expanding their base of operations outside North America in search of undervalued companies and geographically diverse portfolios. Inevitably, many have reached out all over Europe, Russia and Asia, where CEOs and corporate secretaries have little or no experience dealing with dissident investors.

Activist investors will make it their mission to prod those executives into share improvement actions, though their interests and the time frame for a return on investments can diverge quite drastically. Some are short-term extortion artists that will extract stock buybacks or special dividends from management, leaving company coffers empty and long-term institutional investors high and dry. Other activists are governance investors who seek to align distorted executive compensation packages or make sure corporate directors have sufficient incentive to improve both profits and share -value. These governance activists are in it for the long haul, and they often have the tacit or public support of the institutional investor base.

Retail investors hoping to learn from or follow the share-price enhancing tactics of activist investors must be careful to differentiate between the short-term extortionists and the long-term governance investors.

Many private investors jump on board immediately after activist funds take their insurgency campaigns public. (That happens when an activist makes his or her hopes and plans for the company available for anyone to read in a public filing with the Securities and Exchange Commission ). Free riders, as many activists call the cadre of investors that buy into the stock after them, often cash out a few days later, leaving a small spike followed by a dip in the stock price in their wake. Private investors would be better advised to follow the lead of long-term governance investors. Share improvement may take these activists a long time to achieve, but the results are typically better and enduring.