What Happens to the Price of a Stock During a Buy-Out?

Dear SmallIvy,

 What happens to a small junior’s companies share price,  if they are bought out
by a major player? I know the SP would go up straight away, (if it’s an outright
buy by the larger company) and just before the buy out, but is the then
established share price fixed in? Does it retain the new stable price over the
medium to long term? If I didn’t sell straight away? A basic question I know,
but good to establish some fundamentals.

Many regards, Barry

Dear Barry,

You must keep in mind that  the function of markets is to constantly predict the future value of a stock and then set the current price based on the return needed to justify the risk taken.  Note that this is called “discounting.”  If a stock will be bought out in two months at $35 per share, and you buy it at $34.50, you are virtually guaranteed to get a return of $.50 per share for two months investment (virtually guaranteed, because deals do fall through). 

As soon as rumors of a stock buy-out occur, the stock price will often start to head up.  At this point the price offered is not known, so the market tries to figure out what it will be and price the stock just under that buy-out price (in actuality, people continue to offer higher prices until they feel there is no substantial profit to be made, then the price stops moving up).  Note that it is dangerous to buy stocks with takeover rumors since, if the buy-out doesn’t happen, the price can fall quickly.  Even if it does happen, if the buy-out price is less than the market price, you can still lose money.  I still remember buying Stop and Go in the 1970’s for $12 per share, only to have a buy-out at $10 announced a few weeks later.

Once the deal is announced, the price will usually stay near the buy-out price.  Sometimes it may move above it, if, for example, investors think the offer may not be accepted by shareholders and be raised.  If it looks like the offer might fall through, the price may drop. 

I usually find that once an offer has been announced, you might as well sell and move onto something else.  The price can change up until the deal closes, and there is little upside for the risk you are taking.  Also, you are losing the chance of seeing your money grow during that time by keeping it locked up in a stock that probably isn’t going anywhere.  An exception might be if you can delay realizing the gain for tax purposes.  Even still, the risk may not be worth the savings.



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Disclaimer: This blog is not meant to give financial planning or tax advice.  It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA.  All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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