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Summary

  • Small caps have a better chance of being passed over by analysts and keep them from being too large for other companies to consider buying.
  • A stock with plenty of cash flow means there's plenty of room to finance operations and make capital investments.
  • Companies with small overheads will be more attractive to buyers.

It's a hot market for M&A this year as takeover activity soared past $1 trillion already for 2014. It's the fastest pace in 7 years and good news for value investors who aren't afraid to roll up their sleeves and do a little homework to find potential targets.

It's easy to see the appeal of takeover targets. The underlying stock usually gets a considerable boost in its stock price when the deal is announced and investors can reap large profits on rumors alone. However, the odds of successfully buying a stock and it subsequently becoming taken over are large enough that it can't be a singular reason for buying. That doesn't mean it's not relevant though.

The key features that make a company attractive to potential buyers are the same ones that value investors typically look for as well:

  • Small Market Capitalization - Small caps have a better chance of being passed over by analysts and keep it from being too large for other companies to consider buying.
  • High Cash Flow - A stock with plenty of cash flow means there's plenty of room to finance operations and make capital investments.
  • Low Debt - Obviously, an interested party doesn't want to buy a debt-laden company that could drag down valuations. Companies with small overheads will be more attractive to buyers.

A screen with these valuations revealed plenty of stocks. Here are 3 undervalued stocks that could go higher with or without M&A activity.

Renewable Energy Group (NASDAQ:REGI)

This $445 million bio-diesel producer and manufacturer has all the right ingredients that investors look for. It trades at only 9.5 times future earnings with EPS growth next year of 45%. This gives the stock a PEG ratio of just 0.21.

Long-term debt liabilities are a scant $23 million while cash and cash equivalents stand at $153 million. Additionally, total current liabilities are just $98 million. The book value of the stock is $16.31 - 42% higher than the stock's current price representing deep value for investors.

LeapFrog Enterprises (NYSE:LF)

The $477 million educational toy and game maker hasn't performed well lately - down over 13% YTD. However, the company could be an attractive pick-up for toy giant Mattel (NASDAQ:MAT) or Hasbro (NASDAQ:HAS), the latter of which recently purchased Mega Brands for $460 million.

LeapFrog looks undervalued with a P/E less than 6 and EPS growth next year of more than 85%. The stock has a PEG ratio of 0.39 and zero debt liabilities on its balance sheet. Book value for the stock is $6.19, only 10% less than what the stock is currently trading at.

TiVo (NASDAQ:TIVO)

The $1.5 billion pioneer of DVR has expanded itself into being a cable television provider and has already attracted companies like Netflix (NASDAQ:NFLX). Comcast (CMCA) may also be a possible buyer and analysts at Albert Fried have placed a target price at $23 - double what it is today.

TiVo trades at less than 6 times earnings but has a long-term expected growth rate of 48% giving the stock a PEG of 0.12. Quarterly earnings growth year-over-year is more than 107% and like the other stocks on the list; TiVo has a solid balance sheet. Cash and cash equivalents are $253 million while total current liabilities are slightly less - $247 million.

Source: 3 Potential Takeover Targets For Value Investors