8 Stocks an M&A Specialist Would Love

Ten billion dollars will buy you Textron (TXT), a Providence, R.I., conglomerate. Through it, you'll own Bell Helicopter (19% of Textron's 2007 sales), Cessna Aircraft (38%) and a military hardware maker (10%). You'll also get a scattering of industrial goods companies (26%) that make oil rig pumps, windshield washers, golf carts and more. And there's a financing arm (7%) to help your sales staff close deals.

It's a lot of money, $10 billion. But consider what you get for it and how much you would have paid for the same thing a short while ago. Your businesses will likely ring up $15 billion in sales this year and clear $1 billion in profit while generating $750 million or so in free cash. At the start of this year the company went for more than $17 billion.

That sort of sharp, sudden price reduction makes me wonder if I'm getting damaged goods. The helicopter and aircraft businesses, after all, cater largely to corporate bigwigs, whose wigs aren't so big with profits slowing. Bell does some military business, too. Notably, it makes the tilt-rotor for the V-22 Osprey. It's best known for its vertical takeoff and landing capability. Then again, maybe it's best known for being featured on the cover of Time Magazine last October. A sample from the run-on headline: "It's unsafe. It can't shoot straight. It's already cost 30 lives and $20 billion."

There's plenty more to Textron's weapons business, but a gaping federal budget deficit and looming drawdown of troops in Iraq don't bode especially well for war spending. The industrial goods units offer a mixed outlook. Car sales are down, while oil drilling is up. Fortunately, Textron carries a modest $1.8 billion in long-term debt. Or does it? Its finance liabilities total $8.5 billion. That's secured by finance assets of $9.5 billion, but with America's house buyers having trouble keeping up with their payments, investors are no doubt worrying if its helicopter and golf cart buyers will stumble, too.

Valid concerns, all, but Textron's stock decline seems overdone. Sales are hardly stalling. They're expected to increase 15% this year and 8% next year. The finance arm is taking a hit, but it's plenty profitable. Management thinks it will turn an operating profit of $130 million this year, down from $222 million. It has been profitable for each year since its start in 1962. Remaining challenges seem more than reflected in the stock price. It stands at just 10 times this year's earnings forecast, about a third cheaper than the average stock.

Textron turned up recently in my Takeover Targets screen, which looks for companies with low EV/Ebitda ratios. EV is enterprise value, or the cost to buy a company's shares and pay off its debt while applying available cash. Ebitda is earnings before interest, taxes, depreciation and amortization -- a measure of earnings potential that's useful for company comparisons. The screen, then, looks for companies whose total purchase prices seem modest next to their underlying earnings. It's meant to find bargains, not to predict takeovers, although it sometimes does the latter.

For example, we highlighted Longs Drug Stores (LDG) three times after it turned up in Takeover Targets screens, at prices ranging from $22 in August 2004 to $53 in April 2007. Last month CVS Caremark (CVS) offered $71.50 a share for the chain. (The offer expires Sep. 15. Some pension funds that own shares insist the company is worth more. At the moment shares are trading a few cents above the offer price, suggesting only mild investor confidence in a raised offer.)

On the next page, have a look at all eight companies our screen recently turned up, or run the search for yourself anytime using SmartMoney's stock screener. And by all means, if $10 billion is more than you can get your hands on, feel free to buy a handful of shares rather than the whole thing. The dividend is too small to mention but the potential spending on stock repurchases isn't. Management in July announced plans to repurchase $500 million worth of stock in the second half of this year. That's nearly 5% of the company's market value.