You may have heard of the term “mergers and acquisitions” (M&A) before, but you might not know exactly what it means or how it affects your stocks.
What do they mean for individual investors?
How do M&A activities affect stock prices?
And what should you be watching out for when it comes to M&A deals in your own portfolio?
In this post, we’ll break down all of that and more. Stay tuned!
What Are Mergers And Acquisitions (M&A)?
Broadly speaking, mergers and acquisitions are corporate transactions in which one company is bought by another.
This can take a few different forms:
- One company buys another outright and fully absorbs it into the business. This is known as an “acquisition.“
- Two companies agree to merge their businesses, creating a new entity altogether. This is known as a “merger.“
- A company buys a minority stake in another business. This is known as an “investment.“
Why Do Companies Merge or Acquire Other Companies?
In any of the previously mentioned cases, the goal is typically to create shareholder value by combining two companies that complement each other in some way.
For example, two companies might engage in a merger/acquisition in order to:
- Gain market share: By combining forces, the newly merged company will be better equipped to compete against larger rivals.
- Achieve cost savings: The new company can save money by eliminating duplicate costs (e.g., two separate marketing teams) or by taking advantage of economies of scale (e.g., buying in bulk).
- Enter new markets: The merged company can enter new geographical markets or tap into new customer segments.
- Acquire valuable assets: The target company might have some key assets that the acquirer needs, such as a desirable customer list or innovative technology.
What are the Risks of M&As for Companies and Shareholders?
M&As can be a great way for companies to grow and become more competitive. But they also come with some risks.
For example, M&A deals often involve a lot of uncertainty and can be complex and time-consuming to execute. There’s also the potential for cultural differences between the two companies to cause problems down the road. And of course, there’s always the risk that the deal simply doesn’t pan out as planned and ends up being a costly mistake.
From the perspective of shareholders, M&As can be a good or bad thing depending on how they’re structured and what the motives behind them are.
In some cases, M&A deals are done purely for financial reasons and end up benefiting only the executives and investment bankers involved. But in other cases, M&A deals can create real value for shareholders by combining two great companies that complement each other well.
What You Should Know About M&A Deals in Your Portfolio
If you own stocks, it’s important to be aware of M&A activity in your portfolio. After all, a company that’s the target of an acquisition is likely to see its stock price go up (if the deal goes through), while a company that’s acquiring another company is likely to see its stock price go down (at least in the short term).
That said, not all M&A activity is created equal. Some deals are well thought-out and ultimately create value for shareholders, while others are rushed and end up being costly mistakes.
As an investor, it’s important to do your own research on any M&A activity in your portfolio. Pay attention to the details of the deal and try to assess whether or not it makes sense from a strategic perspective.
How Do Mergers and Acquisitions Affect Stock Prices?
M&A activities can have a number of different effects on stock prices, both in the short term and the long term.
In the short term, stocks may rise or fall based on:
- The market’s reaction to the announcement: If investors think the deal is a good idea, the stock price will likely go up. If they think it’s a bad idea, the stock price will probably go down.
- The terms of the deal: If investors think the acquirer is paying too much for the target company, the stock price may fall. Conversely, if they think the acquirer is getting a good deal, the stock price may rise.
In the long term, the impact of an M&A deal on a stock price will depend on how well the merged company performs.
- If the merger or acquisition is successful in achieving its goals (e.g., cost savings, market share gains, etc.), then the stock price is likely to go up.
- If the deal fails to meet its objectives, then the stock price is likely to go down.
What Should You Watch Out For?
If you’re an individual investor with stocks in your portfolio, there are a few things you should watch out for when it comes to M&A activities:
1. The market’s reaction to the announcement
If the market reacts negatively to an M&A announcement, it could mean that the deal is not a good idea and that the stock price is likely to go down.
2. The terms of the deal
In an acquisition, the acquiring company will often pay a premium for the target company’s shares in order to get the deal done. This premium can be reflected in an increase in the stock price of the acquiring company. If you think the acquirer is paying too much for the target company, it might be wise to sell your stocks before the deal is finalized.
3. The long-term performance of the merged company
Even if an M&A deal is successful in the short term, it might not be successful in the long term. If you’re worried about the long-term prospects of the merged company, it might be best to sell your stocks.
4. The combined earnings-per-share:
M&A deals are often good for earnings per share (EPS). This means that the combined company will have a higher EPS than the two companies would have had if they had remained separate. In turn, this usually leads to an increase in the stock price of the combined company.
5. Do the two companies create synergy?
Synergies occur when the two companies that are merging are able to create more value together than they could have on their own. For example, two companies might merge in order to achieve economies of scale (i.e. save money by combining their operations), to enter a new market, or to acquire new technology or talent. If the merger is able to create these synergies, then it will likely lead to an increase in the stock price of the combined company.
6. The Aftermath of a Deal
Once a deal has closed, there will usually be a period of integration as the two companies try to merge their operations. This can often be a difficult and drawn-out process, so it’s important to pay attention to how the two companies are doing.
It’s also important to pay attention to the aftermath of an M&A deal. This is because, often times, the stock price of the combined company will start to decline once the initial excitement has worn off and investors start to realize that the synergies from the deal have not materialized.
The Bottom line
The bottom line is that if you are a shareholder, you should be aware of the risks and rewards associated with mergers and acquisitions. It’s important to understand how deals like these can impact stock prices.
But in order to understand how mergers and acquisitions can affect your stocks, it is first important to understand how to assess the financials of individual stocks/companies. That way, you can make more informed investment decisions.
If that’s something that you’re unsure about how to do and you’d like some help with that, there are 2 resources I can suggest for you to check out:
- The first is our FREE 10 Stock Criteria Checklist, which helps you identify what I consider to be the financially strongest 1% of stocks in the market at any time in less than 5 minutes. Click here to learn more.
- The second is our FREE 90-Minute Online Masterclass, where I’ll show you the 4 key financial criteria for every company I look at, and how I personally anticipate market crashes in advance and prepare for them. Click here to learn more if you’re interested.