There is nothing better than waking up one morning to see one of your stocks up 30% because a bigger company gobbled it up in a sweet takeover with a hefty premium. It is one of the most exciting parts of stock ownership, but it should not be a sole reason for buying a certain stock. You will surely lose money over time if this is one of your main criteria for buying stocks.
Takeover chatter inevitably drives up share prices based on a juicy takeover. This is the worst time to buy a stock because more likely than not, the rumor is just that and you will be paying artificially high prices, which will make the smart money more than happy to take your money. In many cases it is the smart money itself which created the rumors in the first place, so others would bid up the stock. Nobody said Wall Street was the most ethical of places.
Value Investing Bonus
Those who focus on value investing are the most likely to reap the rewards of an unexpected takeover. The leveraged buyout (LBO) crowd is always looking for cheap companies that throw of lots of cash flow to take private so they can unlock value and sell back to the public at a nice profit.
So what are some of the factors to look for? Focus on companies that have low price/earnings ratios, strong and growing cash flows and balance sheets that are light on debt. The market is littered with these unloved gems that are out of favor for one reason or another. For example, the current market loves growth stories such as Netflix (NFLX), Apple (AAPL), and Chipotle (CMG), which might leave others to hide in obscurity.
Stick To Strong Fundamentals
You should avoid troubled companies that are rumored to be the recipient of takeovers. Often times a buyout is the only way these stocks will climb, and that is what you want to stay away from. In many cases there won’t even be a big premium for these types of companies because they are desperate to sell. Just stick to your style and once in a while you will wake up to a terrific present. If not, you still own a great stock.
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