Value investors should be having the time of their lives. With private equity coffers swelled to overflowing and ever-larger deals suggesting that no company is immune to takeover, the fellows who size up investments using a traditional “enterprise value” approach should be hitting the ball out of the park.

After all, the stock selection methods of value investors parallel the screens used by those looking to take companies private. Both types of buyers are looking for free cash flow, conservative balance sheets (which can be levered up in a buy-out), and enduring business franchises. Mostly, both sets of players are looking for solid companies selling at a discount. As private equity firms bid for such companies, similar companies in the same industry tend to rise in value, creating a “pebble in the pond” sort of effect.

The numbers, as we all know, are staggering. Mergermarkets reports that more than $270 billion was spent taking companies private last year in America alone. So far this year, announced deals in the U.S. amount to more than $111 billion.

Also, it’s not just private equity firms that are buying up businesses around the world. Strategic buyers are also on the prowl, adding to the acquisition free-forall. Cullen High Yield Value Equity’s John Gould suggests that the root cause is the pile-up of cash on American balance sheets.

“Cash at the end of the year amounted to $1.2 trillion and accounted for 21% of the total market value of the S&P 500,” Mr. Gould says. “Over the past 25 years, the average is 15%. As companies become lax about reinvesting their cash flow, they become an attractive target for private equity investors.”

All this should bode well for value investors, and indeed, such managers have in fact been outperforming. Morningstar reports that large-cap value mutual funds were up on average 15.8% over the past year, while large-cap growth funds were ahead only 6.5%. Small-cap value funds also outperformed their growth competitors, rising 10.5% over the past 12 months compared with 4.1%. The three- and five-year records for large-cap value funds show annualized gains of 12% and 8%, respectively, compared with 7% and 4.5% for growth.

Mr. Gould has been one happy beneficiary of the buying spree. He owns, for instance, Dow Chemical (DOW $45), which has traded up nicely from the low hit last July of $34, at least in part because of persistent rumors that a private equity bid is in the works. Speculation has focused on Reliance Industries, Kohlberg, Kravis and Roberts, and Blackstone as potential buyers. Although Dow’s management has denied the rumors, the profile of the company, with a trimmed-down balance sheet, solid market share, and perceived potential for cost-cutting and expansion overseas, has kept the chatter going.

Like many value managers, Mr. Gould finds that some sectors have now been priced out of his reach by the very factors that have plumped his returns. The pending purchase of TXU ($65), which Mr. Gould describes as a seminal event, has caused similar utilities to trade higher. Because his firm focuses heavily on dividend returns, the rise in utility stock prices has forced him to go elsewhere searching for yield.

Still, he sees opportunities as U.S.-style consolidation takes place in Europe, in both telecom and utilities. For instance, he owns Enel Societa Azio (EN $55), an Italian electric utility that has traded more than 20% higher over the past several months partly in anticipation of a buyout.

Of course, not every value manager has benefited from the takeover frenzy. In fact, some have found that their traditional valuation models have forced them to sell out of stocks, and sectors, inflated by takeover rumors. Some have actually taken the drastic step of buying ( gasp) former growth stocks.

The manager of the Oak Value Fund (OAKVX), Larry Coats, has experienced both the joys and the sorrows of being a value investor in the midst of a private equity boom. His firm was co-founded in 1986 by two gentlemen, one of whom was one of the original investors with Warren Buffett. (This is the financial industry’s equivalent of having arrived on the Mayflower.) To this day, one of the largest holdings in the fund is Berkshire Hathaway, further cementing their “value” bona fides.

Mr. Coates cites Cadbury Schweppes (CSG $53) as an example of the benefits his firm has derived from private equity’s rampup. At year-end, the stock comprised 4.5% of the fund’s portfolio, and was priced at $43. “We bought the stock because our research showed it to be grossly undervalued,” Mr. Coates says. “It turns out that was the case.”

As it happened, Oak Value was not alone in its appraisal. Attracted by the same attributes, Nelson Peltz has built up a sizeable position in Cadbury’s, and has pushed for the company to break itself up in order to unlock the value in the company’s confection business. This proved a home run for the company and for Oak Value.

However, Oak Value’s head of research, Christy Phillips, suggests that a number of attractive companies have gotten away from them, as private equity players have moved prices in some sectors higher. Also, she points out that Berkshire Hathaway, their largest holding at year-end, at 9.4% of assets, is struggling to find targets for its growing cash horde.

Ironically, Oak Value has moved into sectors once considered off limits to value investors, such as technology. While in 2000 the firm wrote a treatise defending the lack of tech stocks in its portfolio, it now has about 15% of the portfolio in the sector. During the first quarter, Mr. Coates took a substantial position in Microsoft (MSFT $28). The company satisfies Oak Value’s quest for high operating margins and cash flow, and an underleveraged balance sheet. Further, it considers the stock cheap at 15 times forward earnings.

Mr. Gould would argue that Mr. Coats’s foray into what were formerly growth stocks is not unusual. “The contraction of multiples on typical growth stocks has turned them into value stocks,” he says, pointing to General Electric (GE $35) as a perfect example. “GE has underperformed for five years,” he says. “The earnings have been going up, and the multiple has simply declined. Now that the economy is a little bumpier, the trend should reverse.”

Maybe it’s time to look at growth stocks, before the private equity fellows do.

peek10021@aol.com