How to Spot Potential Buyout Targets
When it comes to investing, being the first one to notice something positive before everyone else is the key to making big profits. Value investors pride themselves on spotting intrinsic value in undervalued equities, while growth investors are able to spot long term trends and take advantage of momentum.
While both strategies are valid and serve the purpose of steady returns over time, investing in a stock that get’s bought out at the right moment can have an immediate and often fortuitous effect. These deals are hard to predict and shouldn’t be used as a sole means of investing, but knowing what to look for in advance can improve your odds of owning a stock that could skyrocket in value overnight.
Ripe for the Picking
Companies make deals all the time on Wall Street – sometimes good, sometimes bad. But these buyouts and mergers generally prove beneficial for stockholders of the company that’s being bought. For investors, understanding what makes a company attractive to another is critical in getting the upper hand before anyone else.
The first thing you’ll notice about buyouts is that in almost every case, a larger company buys a smaller company in the same or similar field. For example, a software development company might buy out a smaller competitor to gain market share, or it might want to expand its reach and buy a company that makes processors in order to improve efficiency and broaden their sales base.
For the smaller company, a profitable balance sheet with lots of cash on hand is idea. No company wants to buy something laden with debt, so the fewer debt obligations a company has, the better. It also helps to be under a certain size – general rule of thumb is less than $2 billion. Companies that are too large become difficult to purchase because it means more capital expended or loans to acquire in order to make the deal. Not that these deals don’t happen – anyone who lived through the financial crisis in 2008 saw this with the banking industry.
Finally, a solid buyout target often has market share in a difficult space or occupies a business niche that other companies want. This can be difficult to spot and requires a lot of due diligence and an understanding of the industry environment to get a good read on it.
While finding yourself holding a stock that’s getting bought out can feel a lot like winning the lottery, deals change all the time. There’s a popular saying on Wall Street, buy the rumor, sell the news. In other words, even the hint of a buyout can cause a stock’s price to rise. If the deal goes through, the gain already prices in, but if it falls through, the stock will drop. For investors, that means once a rumored deal is out there and the stock takes off, it might be best to take your profits and move on to the next investment.