Spot the future winners in the takeover boom

This is already the best year for corporate deals, by value, since 2000, with nearly $500 billion (£285 billion) of deals in Europe so far.

The latest is the proposed £7 billion merger of Boots, the high-street chemist, with Alliance Unichem, the European drugs retailer.

Spotting takeover targets can be lucrative; Steer says roughly a fifth of his fund’s 50% gain since launch in November 2001 has come from buying bid candidates.

He snapped up shares in BPB, the plasterboard supplier, in February and it has since soared 44%, after a hostile bid by Saint-Gobain, a French building-materials group, in July.

He also took a stake in Aegis, the advertising business, in June and has since seen the shares leap 45%. In September, the firm became the subject of a bidding war between Publicis, the French media giant, and a consortium of media agency WPP and Hellman & Friedman, an American venture capitalist.

Steer said: “When picking stocks, one of the factors I look for is the potential for a bid, as well as good management, healthy cashflow and a strong market position.”

However, he warns that you have to be on the right side of a takeover. While a bid normally leads to a rise in the share price of the target firm, the acquiring company usually takes a hit.

Companies that have acquired other firms this year paid an average premium of 7% over the target’s share price, according to research by Karen Olney of Dresdner Kleinwort Wasserstein (DKW), an investment bank. “These premiums are enjoyed by the shareholders of the target firms but paid for by those of the acquiring firm,” she said.

And it usually pays to cash in on any gain in the target firm as soon as the takeover is completed, according to Steer, because mergers and acquisitions have a history of destroying returns.

So how does Steer spot a bid target? The first step is to look for firms generating strong cashflow. He said: “Cash is king. Look for firms with operating cashflow at least as good as their profits.” You can find cashflow figures in company accounts, which should be on the firm’s website.

Steer also looks for firms that are relatively small but nevertheless have a strong position in fast-growing markets. He said: “BPB, the plasterboard company, may sound dull but the market is growing fast — plasterboard is cheaper than wet plaster and architects and emerging markets just can’t get enough of it. BPB has a strong position and a global reach, and it was therefore an obvious bid target.”

You may also do better out of deals that are carried out so firms can cut costs, rather than those aimed at boosting revenues. About 35% of companies achieve all their promised cost savings, while only 17% manage to boost revenues as much as expected, according to DKW.

Where is Steer looking for future bid targets? Marshalls, the garden and patio supplier, is one possibility. “It was able to pay a special dividend two years ago and may do so again,” he said. “This makes it very attractive to potential bidders.” The shares cost 287¼p on Friday.

He also thinks there will be consolidation in the housebuilding sector and tips Taylor Woodrow at 314½p or Westbury at 428¼p.

The defence sector is also worth a look. “Firms such as Meggitt, Cobham and Ultra Electronics have good market positions and are much cheaper than their American rivals,” he said.

DKW has also published a list of potential targets. It includes housebuilders such as Berkeley and Taylor Woodrow as well as Alexon, the retailer, Bodycote, the engineering firm, BOC, the chemicals company, and Shire, the drugs group.