For a few years now, we set out to determine a way to improve the odds of success, and to lower the cost, of activist investing.

In 2010, 2012, and 2013, we put together an analysis that, with some standard and novel screens, identified a total of 73 undervalued companies that fit the profile needed to pursue what we’ve come to call “Effective Activism”.

We’ve now updated that analysis, and identified 29 new companies that fit the criteria.

What happened since 2010?

At first, in 2010, some of the results surprised us. A simple valuation model indicated that on average the share price for the 73 companies could appreciate 58%. Also, the companies sat firmly in the small-cap space, with an average market cap of $415 million.

Since then, investors undertook activist projects at about one-third of the companies. Another seven were acquired. For the 73 companies, share prices increased an average of 48% in the three years since that first analysis. That falls within the range of benchmarks for small cap companies.

2014 Portfolio of 29 New Companies

We used the same criteria for another analysis today:

1. ❖highly-undervalued, measured by current net worth and book value relative to market capitalization
   

2. ❖good activist candidates, measured by low insider ownership and high ownership among the top ten institutional investors
   

3. ❖potential value appreciation, measured by a simple valuation using free cash flow and current net worth.
   

In this way, we identify 29 new companies, with a similar profile as the previous 73. On average, at these companies:

1. ❖current net worth of 144% of market capitalization
   

2. ❖book value of 133% of market capitalization
   

3. ❖insiders own 4%, and the top ten institutions own 53%
   

4. ❖discount to potential share price of 42%, implying 72% potential share price appreciation.
   

Relative to the earlier analyses, the value potential of this group of 29 companies is slightly smaller, while the potential price appreciation is slightly greater.

What’s a fund to do?

The analysis also illustrates how this approach can make a different to investors, particularly fund managers that collect fees for management and performance. Spending relatively little, say under $100,000, on an activist project, makes a vast difference relative to the standard cost of $1 million or more. Assuming 72% share price appreciation, an average investment of about $11 million, and customary fees, we estimate that the effective approach can eliminate cost as an obstacle to an activist project.

Now, the strategy isn’t objectively easy – no activist program is. Management still holds many of the cards. They can spend company (shareholder) money to seek support from shareholders outside of the top ten investors, and can communicate with shareholders in ways that investors cannot.

Still, for the right companies (such as these 29, and perhaps others) this approach should make it easier for an investor to have an impact.