“Zach, I’m not paying you to sit on a pile of cash!”
I had to hold the receiver away from my ear. Joe was shouting in his thick New England accent from his office in Boston.
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“I pay you to INVEST my money! And if you can’t do that, I’ll find someone who CAN!”
You see, when I worked at a private hedge fund in Atlanta, it was my job to not only invest for our funds, but also to manage the personal accounts of some of our most wealthy clients. And on this day, one of our wealthiest clients was giving me an earful.
At the time, Joe’s account was halfway invested in some conservative stocks that I had researched. And half of his account was sitting in cash. The market was unstable and I was concerned that stocks might trade lower. And I didn’t want Joe to lose money if that happened.
But Joe wouldn’t have it…
Joe wanted his money working for him. So over the next week, I put Joe’s dry powder (or available cash) to work, picking out the best stocks that I could. After all, it was his money and if he wanted it in the market, then I had to follow his instructions.
Today, some of the biggest investors in the world are in a similar position.
And with nearly $1.1 trillion in cash on the sidelines… and customers who want to see it put to work… that cash could ignite a buying frenzy in a handful of key stocks!
Today, I want to show you where that cash is headed, and how you can profit when the cash goes to work.
Enough Dry Powder For An Explosive Market Jump
Private equity companies are swimming in cash.
These investment companies collect money from their clients (typically uber-affluent individuals along with pensions and endowments), and then invest that money in specific opportunities.
The companies typically have different strategies for how to invest the money. Some focus on real estate transactions, others on market opportunities in one sector or another, and some buy out entire companies.
Buyout firms are especially interesting because they typically use cash to make the acquisition, and then use their contacts and expertise to improve the company that they bought. Ultimately, these companies will be sold again and the private equity company (along with their clients) will lock in huge profits.
This week, I saw an updated chart that shows just how much cash these buyout firms have on hand.
Over the past several years, the amount of dry powder these firms hold has continued to increase. And in just the first three months of 2018, the available cash has jumped by nearly $100 billion!
Investors in these private equity funds are not going to stand for their money to be sitting idle on the sidelines. The investors are paying private equity firms to DO SOMETHING with this cash.
And with the market’s recent pullback, it’s going to be a lot easier for private equity companies to justify making some big investments!
The Year Of The Takeover Deal
I’m expecting 2018 to be “the year of the takeover deal.”
In other words, there are going to be many takeover deals announced as this cash is put to work.
Takeover deals can be very lucrative for investors — if you know how to spot them ahead of time.
That’s because when a private equity company decides to take over a company, they have to offer a lot of money to get the deal done.
Typically, a private equity company will make a cash offer to buy all the outstanding shares of a company. If the offer is too low, the company’s management will reject the offer. And even if the management team accepts the offer, shareholders like you and me have to vote to accept the deal.
In order to get deals done, private equity companies have to offer attractive prices. And those offers naturally send stocks higher.
Today’s investors are already starting to position themselves to take advantage of these coming offers. According to Business Insider, stocks that are considered prime targets for buyout firms are currently beating the market by several percentage points this year.1
In other words, investors are getting in front of these private equity buyout firms by investing in the best buyout stocks ahead of time. When the deals are ultimately announced, these investors will be able to lock in some very large overnight profits.
Finding The Best Buyout Candidates
When I look for buyout candidates, I have a few specific things that I like to see.
First, I look for companies that have large untapped growth opportunities.
For instance, a regional company might have the potential to expand nationwide — if they simply had the resources to cover more ground. Or maybe they have a specific drug or technology that could be sold to a much larger audience.
Second, I look for potential improvements that could be made.
Maybe the company’s balance sheet has too much debt. Or it’s possible that the management team isn’t skilled at a particular part of the business.
This is important because a private equity firm could quickly fix these issues. So the company might be a great target to take over, make an adjustment, and then sell at a higher price.
Finally, I like to see companies that are small enough to get bought out.
For this, I typically look at the market capitalization of a particular stock. This is the dollar value of ALL the shares of a particular company. The lower the market capitalization, the easier it is for a private equity company to spend some cash and take this company over — even if they have to pay a premium price!
This article originally appeared on The Daily Reckoning.