Profit in a Shrinking Market

Back in 1996, there were 8,025 publicly listed U.S. companies. Now there are less than half that many.

In 2012, the number had fallen to 4,102. Last year, it hit 3,618.

At the same time, there are more and more non-U.S. companies listed on the exchanges.

From 1996 to 2012, that number grew from 30,734 to 39,427.

Those are some worrying statistics.

You see, according to historic trends and U.S. economic development, we should have around 10,000 publicly traded companies by now.

That means there’s a “listing gap” of nearly 7,000 companies.

Where’d They All Go?

For starters, a bunch of companies haven’t been able to meet the necessary standards to be listed on major exchanges. Recently, energy companies have been the prime example of this.

If a company can’t meet minimum sales requirements, keep its stock price high enough, or maintain certain financial ratios, it gets a warning. If it doesn’t get its act together, it gets the boot.

Now, sometimes a company chooses to get delisted. If the benefits of being publicly traded don’t outweigh the costs of being listed on an exchange, management will pull the company and go private.

Another reason a company might choose to be delisted is if it merges with another and the new entity wants to trade under a new symbol, or if it’s acquired and the acquirer just merges the two businesses together under its ticker. 

And that’s been a big reason for the drop in U.S. companies available on major exchanges.

Gobbling Up the Competition

Over the past 20 years, there’s been a huge increase in mergers and acquisitions. According to Dealogic, even during the recession years of 2008 and 2009, there were 8,778 and 7,415 buyouts, respectively. Those numbers grew as the country came out of the recession and hit 10,108, 10,518, and 12,194 in 2010, 2011, and 2012.

Even the exchanges themselves are getting bought out. Back in 2012, Intercontinental Exchange bought the NYSE’s parent company, NYSE Euronext.

Want some more startling numbers? Between June 12 and June 26 of this year, there were over 100 mergers and acquisitions by U.S. companies. That’s nearly 10 per day in the second half of June — the slow season on Wall Street.

100 Acquisitions in 15 Days
Click Images to Enlarge

Organic growth is practically dead. If a company wants a new technology or wants to get into a new market, it doesn’t develop things on its own anymore. It just goes shopping for another company that already has that tech or already has a foothold in that market.

Amazon wanted to get into food. In my opinion, it also wanted to squash the Blue Apron IPO at the same time. So, what did it do? Went out and bought Whole Foods. Obviously, that gets Amazon a foot in the door of the grocery store. But it also gets the meal delivery service WFM had been building.

And what happened to the Blue Apron IPO? Postponed. And priced lower than expected.

IP-Oh No

That’s another reason the number of public companies is falling — there are far fewer IPOs. Companies are choosing to stay private. And why wouldn’t they? They can get super high valuations. They’re raking in big bucks from private equity investors. And they don’t have to answer to shareholders.

Usually a company goes public so the founders can cash out and so the company can get access to way more funding from the investing public. But if the founders are already making billions and PE is already pumping billions more into the company’s accounts, there’s really no reason to step into the ring and issue stock.

Back in 1999 and 2000, there were 486 and 403 IPOs, respectively. In 2011, there were 125. In 2012, there were 128. Last year, there were only 105. And as of the first quarter of this year, we’d only seen 24. At that pace, this year will be even worse than 2016.

Then there’s the case of companies like Dell and Heinz. They decided they don’t want to play in the markets anymore. So, they’re taking their balls and bats and going home. Neither of them is going to trade as an independent company anymore.

Fading Advantage

So, what does that mean for us as investors?

Well, for one, there are far fewer options out there when it comes to buying stocks. Unless you’re able to invest in private companies, you’re looking at a dwindling number of places to put your money.

Some people still think Wall Street is a rigged game. But the ability to invest in American companies the same way a multimillionaire or billionaire can is one of the defining parts of our capitalist system.

The stock market takes away the barriers between the public and the super-wealthy. It’s an even playing field in a world where those don’t really exist.

But with fewer and fewer companies available to the average investor, that field is getting a serious tilt in favor of uber-rich folks.

It’s also possible that valuations on the remaining companies are so high because investors are desperate for somewhere to put their money. The pickings are getting slimmer and slimmer. So, they’re piling more and more money into fewer and fewer companies.

That has to affect the valuations of the companies. Of course they’re growing. There’s nowhere else to invest.

Getting More Profits with Fewer Choices

So, what can investors do to get the biggest profits from a dwindling pool of investments?

IPOs are stagnant, so, while you might catch a good one, there’s not much promise there.

But the trend of mergers and acquisitions is one you can use to build some really big profits. All you’ve got to do is figure out who’s getting bought and invest before anyone else catches on.

It’s not the easiest thing in the world, but it’s possible. And I’m going to get you moving in the right direction with some things to look out for:

1. Watch Industry Growth

Strong growth in an industry often gets the M&A juices flowing. When a company has made a bunch of cash and has a nice, high valuation, it’s more likely to consider buying smaller peers. If an industry is getting ready to spread globally, investors can look at smaller companies that would add distribution networks or necessary technology to a firm looking to expand.

2. Look for Focused Businesses

If a company has a solid product line that would fill a gap in a larger firm’s operations, it’s going to become a target. Also, if a company has assets that are tough to duplicate — like coveted customers — it’s going to come up on the radar of larger firms. Think WhatsApp getting bought by Facebook for its customer list.

3. Underperformers Can Outperform

Underperforming companies make great targets. They’ve got low valuations, and that makes them a cheap purchase for a larger firm. And they may have a great business plan but not be running it efficiently. Sears is a target because it’s not making money but still has great brands like Kenmore.

4. Follow the Free Cash Flow

If a company is going to buy another one with debt, then it’s going to need a steady stream of cash coming back to pay for the loan. So, it’s going to be on the lookout for targets with low debt, high cash balances, and a price that’s less than six or seven times its free cash flow. Also, if a stock is priced less than three to four times its cash per share, it’s going to make an attractive purchase, too.

5. Halfway Bought

A lot of times, companies will build up holdings of other companies’ stock. Once they’ve got enough, they’ll make an offer to buy the rest. Nokia did this with Alcatel-Lucent. So, keep your eyes out for firms with large partial ownership stakes by other companies. And if a stock has several big owners, it’s got an even better shot of being bought out. It’s far easier to convince four or five institutional investors to sell than it is to convince thousands of small owners.

6. Listen to Managers

It’s not odd for a company to announce it’s looking to grow or diversify. And usually that means buying another firm. So, when you hear about that, start considering where it wants to move and find yourself a likely candidate for purchase. Also, some companies will talk about pursuing strategic options. That’s just a fancy way of saying they’re trying to find a buyer. And even though it’s no secret that they’re looking, you can still get some big profits when they finally find a match.

Only Buy the Best

Now, it should go without saying that you shouldn’t just buy a stock solely because you think it’s going to get bought out. But I said it anyway. Because it’s important that you’re still investing in solid companies. If the buyout never materializes, you’ll still have a stock that’s going to grow over the long term.

My subscribers at The Wealth Advisory are invested in Twitter.We’re looking for a buyout. And I’ve got a target of $25 on that. But if that buyer doesn’t show up, it’s still a solid company capable of growing revenues and earnings and making a tidy profit in the long run.

My readers just got into another potential target this month. And this one has a solid business and growing revenues to keep profits rolling in with or without a buyer, too. I expect we’ll see our stock purchased by a larger firm within the next year. But if it takes longer or doesn’t happen at all, I still see this one netting us at least a double-digit gain.

You can invest along with my Wealth Advisory subscribers or go it alone. Either way, follow the seven rules I set out above. And you’ll be well on your way to making some big profits in this shrinking pool of investments.

To investing with integrity (and a leg up on the competition),

Jason Williams
Wealth Daily

Follow me on Twitter @AllBeingsEqual