Who's the next buyout candidate?

This is by no means an easy question to answer. Smart Millionaire Zone investors seeking the next ripe apple to fall have a lot to look at, including business fundamentals, market leadership and trophy holdings in a company's asset base.

I like to look at cash. Companies with a lot of free cash -- that is, unencumbered by other business needs -- attract me.

Why? Because the buying company can do anything it wants to with the cash, including financing the acquisition. And because it lowers acquisition risk, free cash is probably the most tangible asset there is.

So how do you find companies with a lot of free cash? Well, it's not so easy, at least for individual investors -- professional screening tools that do it aren't generally available.

While individuals can find cash-rich companies by looking at financial statements, automating the process is pretty tough.

When I looked for a cash screener in commonly available investment portals and broker platforms, I didn't find much. The closest solution came from Fidelity Investments, but you must have an account (although it can be just a retirement account).

Fidelity's screener can search by the "cash to price ratio." Defined as it sounds, this ratio calculates balance-sheet cash per share as a percentage of share value. A cash/price ratio of 0.25, for instance, means that 25% of the share price is covered by cash on hand.

Click here for the video version of this story from Jennifer Openshaw.

If you don't have access to a screener, teaching you to fish for the numbers won't be that helpful. So I'll give a few tips, then -- some fish -- in the form of investing ideas I found.

First of all, even cash isn't always what it appears to be. There are some pitfalls to cash-driven investing:
  • Cash isn't always "free." Be careful with companies that have large cash balances but also substantial liabilities or capital-investment requirements. Look for cash in excess of debt, and look in the statement of cash flows for large negative balances in the investing activities section.
  • Cash can be inventory. For most banking and lending companies, cash is, in effect, inventory. So how much cash the company has on hand at any moment is more a matter of timing than true business value.
  • Cash can be from IPO or stock sales. Many brand-new companies in launch phase haven't spent their cash yet. It isn't earned from operations and will probably be spent for capital goods or some other longer-term commitment.

So, now to the screen I ran. First, I set cash-to-price ratio greater than 0.3.

Then, to find companies attractively sized for takeover, I set market capitalization between $500 million and $1 billion. To sift out IPOs and companies pulling cash from somewhere outside of operations, I set P/E less than 25.

Finally, I'm looking for undervalued companies, so the price must be in the bottom half of its 52-week range.

Most candidates are in the financial services industry, but I cut them for the reasons I cited above. Interestingly, several are in the tech sector, where profit margins are high and intellectual capital investments tend to pay off in cash.

Here are my picks:
  • Molina Healthcare (MOH) is a regional health care provider specializing in Medicaid services, with $404 million in cash on a market cap of $870 million and a forward P/E of 17.
  • Kellwood Corporation (KWD) is a low-profile retail and outdoor-wear provider, with brands ranging from Gerber Beginnings to Kelty and Sierra Designs. The company sports $341 million in cash on a market cap of $733 million.
  • Coherent, Inc. (COHR) is an OEM supplier of lasers, and has $325.9 million net cash against a $950 million market cap.
  • Countrywide Financial (CFC) is where I break my rules about financial services providers and market cap. This lending giant has some $23 billion cash against a market cap slightly smaller than that. Yes, there's some debt, but not a lot for a company its size, and it's already rumored to be on the takeover block.

While cash attracts, you should peek under the financial hood to see what's really there. Low stock prices sometimes mean a company doesn't have good uses for its cash, or isn't likely to spend it appropriately. All the same, I like money in the bank.

As originally published, this story contained an error. Please see Corrections and Clarifications.

Jennifer Openshaw, a passionate advocate for helping Americans improve their finances and build their personal fortunes, is author of the hit new book The Millionaire Zone founder of The Millionaire Zone, and AOL's Personal Finance Editor. In addition to appearing regularly on such shows as Oprah, CNN and Good Morning America, Jennifer is host of ABC Radio's Winning Advice and serves as an adviser to some of America's top corporations. Visit her at www.themillionairezone.com.

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