Deals are driving prices higher, so making money should be easy—theoretically. Here are stocks (and target prices) that are worth watching.
Acquisition frenzy is upon us. August is on a path to be the second-biggest August ever for corporate takeovers. Making a profit as one of these deals drives a stock's price up ought to be as easy as shooting fish in a barrel.
Except it's not.
Many of the barrels are devoid of deals: Fire away as you like at these sectors, but you won't hit anything. Others are full of minnows: Nothing you hit is going to be worth the ammo.
There is a way to improve the odds, though.
If you understand the reasons behind the surge in acquisitions, you can figure out where the big fish might be hiding. (For more on the acquisition boom, see "Time Is on Investors' Side.")
That can help you eliminate some barrels and prioritize others.
Using that process, I've come up with three acquisition candidates that I think are worth putting in your gun sights.
Why They're Buying
Two motivations are driving this acquisition trend.
For companies and their CEOs, acquisitions mean a shot at higher profits in two ways. First, there's industry consolidation. You're probably familiar with this story; it's the motivation for deals such as BHP Billiton's (NYSE: BHP) $40 billion hostile bid for Potash of Saskatchewan (NYSE: POT).
Consolidation works to increase profits because it eliminates competitors who might have been tempted to cut prices to grab market share, and it produces significant increases in profit margin as companies shutter inefficient facilities, combine redundant operations, and reap efficiencies of scale.
There's also the advantage of vertical integration. A company that can make steel, supply the iron ore and metallurgical coal that making it requires, do the trading to buy these and other necessary raw materials, sell the finished product, and maybe even transport it has the opportunity to capture more of the "value chain" than a company that specializes in just one of those functions.
The effort to add the last piece of this structure—the internal trading operation—is also behind many of the cross-commodity acquisitions of the past year or so. If an iron miner and steelmaker wants to build a trading operation, buying an oil producer makes sense because it increases the company's trading clout in the global markets.
Understanding this motivation won't help much in indentifying barrels full of fish, but once you've selected the barrels to shoot at, any fish you aim at should be an acquisition target that helps an acquirer apply this logic.
But Which Sectors?
To find the barrels themselves, look at motivation number two for acquisitions.
For companies, especially in state-controlled, state-funded, or state-influenced industries, acquisitions are a way to gain access to raw materials in a world where ready supplies of commodities at reasonable prices are by no means guaranteed. Can't run a steel industry without iron ore or metallurgical coal. Can't make a profit in that steel industry if the prices of raw materials—from independent suppliers that want to make a profit themselves—keep rising. Acquiring the supplies and suppliers of the raw materials you need solves these problems.
This is the logic that can help you identify the right barrels to aim at.
And I think it points at three barrels: Iron ore, metallurgical coal (used in turning that iron ore into steel), and thermal coal (the coal used by utility power plants).
NEXT: Quest for Iron Ore; Great Coal Rush