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What You Need To Know About Mergers For Stock Market Investing

By Jason Markum

In all my years investing in the stock market there’s one thing that I’ve come to understand with absolute certainty; and that is… there is nothing absolutely certain about stock market investing! As soon as you learn a surefire way to make money, everything changes and you have to learn something new or get lost in the dust.

A great way to make money in the stock market is to invest in mergers and acquisitions before they happen. But before you do that you have to know several things about mergers and acquisitions.

One reason why mergers are so lucrative from an investment point of view is that most times when one company buys another company they have to pay significantly more than the current stock price in order to convince the company to sell. If a stock is currently trading at $20 a share for instance, a company may have to offer $45 or $50 per share in order to convince the company to sell out. That’s quite a jump in share price virtually overnight and if you own that stock while it’s at $20 you stand to make a lot of money very quickly.

It’s hard as a small investor to take advantage of these things because merger leaks often filter to large institutional investors first. This has one significant effect… the institutional investors run out and buy massive chunks of stock immediately if they think the merger is going to take place. This excess buying drives the stock price up close to the target price for the merger.

Taking our original example, if a stock is $20 a share, the institutional investors will start buying it until it reaches nearly $45 or $50 a share, which is the price that the new company is going to pay in order to buy out the old company. Many times this buying activity will occur before you as an individual investor can get wind of it (and profit from it!).

But if you do happen to hear about it or deduce it yourself, the ride up can be exhilarating!

People who buy stock at low prices in the hope that the stock will rise due to a merger are called arbitrageurs. They hope to profit from the arbitrage between the original price and the merger target price. They often have an advantage over small investors in that they can buy in bulk without the high trading costs that individual investors usually have to pay which makes arbitrage profits higher for them then they will be for you.

Finally, there is significant risk in this sort of an investment strategy because mergers and acquisitions don’t always go through even when they’ve been announced. Many times two companies start haggling over different things and the merger talks fall through and the stock price sinks back to its previous level or sometimes even lower. That is the main risk involved in this sort of investing and is something that you are going to want to account for in a significant manner.

There may be a lot involved in speculating on mergers and acquisitions, but the fact remains the same… all it takes is a few guesses correctly and you can stand to make a lot of money very quickly. It’s a heck of a game!

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