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This weekend's Barron's had an interview with Roger Vogel of Silvercrest Asset Management, who likes the idea of investing with the potential for consolidation ahead. I tend to agree with his statement that:

we firmly believe there is going to be a very big merger-and-acquisition cycle, mostly focused on small-cap companies.

He elaborates that those with strong balance sheets are likely to fare the best in a continued environment of tight credit.

I have noticed lots of deals lately, though most of them tend to be strategic rather than financial. While I never invest solely with the expectation of an acquisition, it is something that I increasingly incorporate into my views.

Inspired by Vogel's hypothesis, I decided to run a screen to try to identify stocks that might look attractive to potential suitors. I took the Russell 3000 and narrowed it to companies with strong balance sheets, high historical returns on capital and low capital intensity. My screen ended up with 171 companies, but most of them were very small. For the purpose of this article, I limited it to names above $1 billion in market cap. Note that one of them received an acquisition offer just this week (Zenith) (ZNT). The 33 names below met the following criteria:

  • ROC: 5yr Average > 10%
  • Net Debt to Capital: < 10%
  • Total Liabilities/Current Assets: <67%
  • CapEx/Revenues: <5%

Here is the group that made the cut (click to enlarge):

Cheap Stocks in the Russell 3000 above 1bln
7 of the 10 economic sectors are represented. I highlighted expected PE ratios that are below 12 as well as Price to Tangible Book ratios below 2. I also highlighted the name if it is a stock in my watchlist and the symbol if I own it or it is in one of my Model Portfolios. I can't comment on all of these, but I do believe that Lufkin (NASDAQ:LUFK), Clarcor (NYSE:CLC), Wolverine World Wide (NYSE:WWW), Fossil (NASDAQ:FOSL), Timberland (NYSE:TBL), Columbia Sportswear (NASDAQ:COLM), Wellcare (NYSE:WCG), Immucor (NASDAQ:BLUD), Dionex (NASDAQ:DNEX), Quality Systems (NASDAQ:QSII), HMS Holdings (NASDAQ:HMSY), Microstrategy (NASDAQ:MSTR) and maybe Plantronics (NYSE:PLT) could fit strategically for larger acquirers. I don't believe that Buckle (NYSE:BKE), Men's Wearhouse (NYSE:MW) or Plexus (NASDAQ:PLXS) are potential targets, but they are all very cheap in my view.

If you find this interesting, you should really check out the complete list. Many of the companies have little or no analyst coverage. I have highlighted the names I either own or that are in one of the model portfolios - there are a total of 9. Considering the combined total number of names in the model portfolios or the foundation is just 27, you can tell that this theme is important to me. I will be perusing the complete list further. If you would like to check it out too, just click here.

Disclosure: Author is long BKE and TBL in a portfolio I manage or in at least one model portfolio.

Source: 33 Mid Caps With Strong Balance Sheets That Look Ripe for Acquisition