The 2007 stock market has experienced significant growth, pushing past historical highs and significant resistance levels.  However, this rise in the stock market has not been prompted by strong economic factors; in fact, the growth in the market has continued despite signs of a recession and housing crisis. The key to the market growth in 2007 is attributed to corporate stock buybacks and the rash of corporate buy outs that have peppered many industries.  Although the market and investors rally at the announcement of an acquisition, most of these gains are unsustainable in the long term, and it is important that you shield your portfolio from the fluctuations.

Rallying with the announcements

When companies are targeted for acquisition, its stock price enjoys a strong rally.  Traditionally, the private equity firms looking to buy out the target company have extensive amounts of money to invest; thus, they are willing to pay a higher premium for control of the company.  For example, when Blackstone Group targeted Hilton Hotels as a corporate buy out target, they paid $47.50 per share, which was nearly 40% more than the stock price before the announcement. 

Thus, stock market investors, whether institutional or retail, can jump on the corporate buy-out bandwagon early – and ride the rally all the way to the top.  In fact, when an announcement or news begins to circulate about corporate buy out moves, the entire sector enjoys a lift into higher prices and increased popularity.  The market and investors prepare themselves for future potential in other corporate buy out scenarios in the industry.  Many investors’ portfolios have surged in value from these types of trades, but the question remains whether these gains are sustainable. 

Viewing the long-term picture

As nearly almost every stock industry has experienced corporate buyouts recently, with investors and analysts scrambling to predict the next target, many of these stocks already have a premium priced into its current value.  Thus, for many investors, even if they get in quickly after the news of a corporate buy out, the returns are less than anticipated. 

However, in analyzing the overall picture, most of these corporate buy-outs are not sustainable in the long-term.  Unless the two companies have tremendous synergies, corporate buy outs often do not live up to the expectations.  Historically, most corporate buy outs suffer once a recession hits, with bits and pieces of the companies sold off for financing purposes.

Thus, what is a retail investor to do?  If you are considering cashing in on the corporate buy out rallies, it is important to act quickly and view the stock as a short-term investment.  The sooner you can get into a stock targeted for takeover, the higher your potential profits will be; instantaneous news feeds from your brokerage and NASDAQ Level II access can assist you in identifying these opportunities. 

However, before you enter into the trade, you should consider setting parameters for your gains and ideal exit points.  Thus, you can sell the trade, pocket profits, but remain protected from the exuberance of corporate buy outs that eventually lead to pricing declines.