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Find Suitable ‘At Risk’ Candidates

Activist managers in the world of hedge funds have been around forever and value investors in the US have been turning up at the gates of the giant corporates since the end of the Second World War.

These buccaneers have been called various names over time, but one idea links all their battles: they like to target a decent company with solid fundamentals (characteristics making it a potentially strong company to invest in) that has lost its way and needs a new sense of direction, which the existing management probably can’t provide.

This logic suggests a simple focus for you as an investor. Look for companies with decent fundamentals and sound business structures and see whether a shareholder activist is lurking on the share register.

Crucially, make sure that room exists for some upside in the share price. Activists are unlikely to turn up at fabulously successful companies where the management are fab and the share price has already exploded. Apple for instance is unlikely to be a target for shareholder activists while its iPhones still rule the world, though that can all change after a few strategic mistakes!

Activists are more likely to emerge at companies with a mismatch between the share price and the total value of all the assets on the balance sheet. They also look to pick on companies with lots of cash swilling around but where that money is being badly spent by the managers (usually on executive pay and wasteful acquisitions).

Like all great investment strategies, the success of following the activist is largely about getting your timing right. When everyone joins in the merry game, the share price can move sharply and the opportunity for more profits begins to fade the higher the share price goes. The tactical and agile succeed at this strategy.

You also need to stay alert for two additional factors:

  • Managers can put up a very effective fight. They may see off the activists and then slip back into their bad old ways — dragging down the share price yet again!

  • Activists’ vitriol aimed at a board of directors can become corrosive to the company’s future. If investors start to think that matters have become dismal, the share price can keep on falling and attract the attention of vulture investors who sense a corporate crash. Short-sellers may emerge en masse, selling the shares to push the price down and make money — which spells disaster for your activist strategy.

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