Buying on Take-over Rumours

November 7th, 2012 by Potato

Someone asked me a few days ago if I thought he should buy some Netflix stock, based on a report that Microsoft was rumoured to be interested in taking it over. I gave him an emphatic no. Not because I had any idea as to what would happen with Netflix — it might very well go through at a really high premium — but because a take-over rumour on its own is no reason to be buying something.

For one, even if the take-over talk is legitimate, by the time the rumour has percolated to you (usually through some form of mass media) it’s too late and everyone has already acted on the news (i.e. the stock price is already up).

For another, there are like 5 take-over rumours for every take-over that actually happens (if the ratio is even that good). Heck, just searching for Microsoft take-over rumours turns up the ones on Netflix, but also Nokia, RIM, something called Yammer (which turned out to be true), Activision Blizzard, Rdio, Glu Mobile, OnLive, EA, Adobe, and two separate ones on Yahoo (one of which was a legitimate offer by MS, and another an unfounded rumour years later).

Of the take-overs that did happen, such as Microsoft buying Skype, I don’t think there was any hint of it in advance.

If the only reason to buy a company is because of a take-over possibility/rumour, and the price has already moved up a bit because the rumour is out there, then you could lose money if/when the take-over is finally denied (see: Yahoo) and the price reverts. If the takeover does happen, then often the price will jump even higher – but a 1 in 5 chance of making 20% doesn’t really work as an investing strategy.

Now that’s not to say that you shouldn’t buy a company just because there’s a take-over rumour swirling: some companies are good values and odds are another company will recognize that and take them over. But if it’s a good value, you likely won’t care one way or the other (indeed, you may wish there wasn’t a take-over so you could still own them – I’ve often felt that way about Teranet and a few other little companies like that that were scooped up by the pension plans in the last 5 years).

Take-over rumours just aren’t a good basis for making investing decisions, one way or the other.

One Response to “Buying on Take-over Rumours”

  1. Sunday Morning Dump: U.S. Erection Edition - Financial Uproar » Financial Uproar Says:

    […] Holy Potato says you should never buy a company based on a takeover rumor. But what if you know like, for sure, that it’s gonna happen? Huh? Didn’t think of that, didja smart guy? […]