One of my favorite investing adages is to think like a private equity firm and not a short-term trader. Taking the long view of our stocks and buying assets and earning streams at low multiples and holding them for several years instead of a few weeks is a much more successful path for most investors.
It can also pay to think a little bit more like the PE guys and maybe even a little ahead of them by looking for the same things they do when buying a company. I’m primarily an asset-based investor, but everyone once in a while it is useful to gaze around the markets through the lenses of a private equity buyer and see what I find.
I have been known to hang around all sorts of thoroughly disreputable types over the years and at least a few of them have been private equity types and LBO managers. When I ply them with strong drinks and get them to divulge their secrets I have discovered that, generally speaking, they are looking for decent businesses trading at an enterprise-value-to-EBITDA ratio of 5 or less with lots of equity in the balance sheet so it can be leveraged up if necessary.
That is a fairly easy set of criteria to screen the market with, so I sat down today and l looked for stocks that might appeal to a long-term private equity investor.
One company that catches my eye right away when I run this screen is surf and teen retailer Tilly (TLYS). My daughter was an assistant store manager for Tillys while she was in college, and I was always impressed by the company. It is one of the better-managed retail chains I have come across over the years.
TYLS stock is down after missing analysts estimates, but this is a pretty good business at a decent price. It isn’t a book value bargain by any means, but the EV/EBITDA ratio is just 5, and the company has very little debt on the books. It generates pretty healthy levels of free cash flow most years, and although I won’t predict a takeover I would not fall out of my chair in shock if a PE firm decided to add the company to its portfolio either.
I have no idea how LeapFrog (LF) has not already been snapped up by either a strategic or financial buyer yet. The company line of electronic toys and technology-based learning products is begging to be part of a larger or nonpublic enterprise so LF can get away from the short-term earnings focus of Wall Street and continue to develop their product line. This is a fantastic business that has an EV/Ebitda ratio of just 4.6 and has almost $80 million in cash and no debt.
Oil companies dominate the list, but I don’t see anyone raising the tens of billion in would take to buy Apache (APA), Hess (HES) or Marathon Oil (MRO) but a series of strategic mergers in the oil and gas industry are a probability this year. We are getting close to the point where oil is cheaper on Wall Street than it is in the ground.
Looking at stocks through the eyes of private equity investors can help investors spot bargain opportunities and discover sectors that may be vulnerable to increased merger activity. Snap them up now before the opportunity passes by.
As of this writing, Tim Melvin did not hold a position in any of the aforementioned securities.