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Why a RIM takeover rumour is a horrible reason to invest

A view shows a Blackberry Z10 device at a Rogers store in Toronto February 5, 2013. Tuesday marks the first day the Blackberry Z10 with the BB10 operating system goes on sale to the public in North America.

MARK BLINCH/REUTERS

One of the big hopes for investors in Research In Motion Ltd. is that a well-heeled company will buy it for the value of its patents and the potential of its BlackBerry smartphones, rewarding investors with a sweet premium over the current share price.

The problem with this hope is that it has been hanging over the stock, publicly at least, for some 15 months. And the share price today is no higher than it was in late 2011 – though it dipped as low as $6.10 in Toronto last year, presenting a severe challenge to investors to hold on for that envisaged takeover premium.

BlackBerry illustrates how difficult it is to pick a stock that is indeed a takeover target, and get the timing right so that when the takeover occurs you'll make a profit.

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In fact, it is so difficult that most investors shouldn't even try.

Admittedly, the temptation is strong. Academics note that the average takeover premium ranges between 30 to 40 per cent.

And there are standouts. In the biotechnology sector, the average takeover premium has been a stunning 115 per cent above the market price, based on recent transactions tracked by Deloitte.

But just as lottery winners don't prove that all lottery tickets are winners, acquired companies don't prove that every stock is a target.

Some investors believe that underperforming companies are ripe for acquisitions, because their beaten-up share prices have put them into the bargain bin.

But there are a lot of under-performers out there. Within the S&P/TSX composite index, 57 companies have fallen 20 per cent or more over the past five years. These laggards represent nearly a quarter of the index.

Selecting the right stocks that are about to become takeover targets requires luck, and your timing has to be right as well. If you select the wrong stocks, or get the timing wrong, your portfolio will be weighed down with duds.

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If you think you can increase your odds by only targeting companies that have been touted as takeover prospects, you are also likely to be disappointed.

For one thing, rumours can circulate for a long time before anything happens, as the takeover rumours surrounding BlackBerry have ably demonstrated. If a deal is eventually struck some time down the road, there is no guarantee the takeover price will prove to be profitable for you based on what you paid for the stock.

For another, open rumours about a takeover are more than likely to be built into the share price already (Hey, you're probably not the first person to hear about them).

There is some evidence to suggest that rumours force acquirers to pay-up even more for their acquisitions – but the pricier a takeover gets, the more likely it is for a company to walk away.

This isn't to say that you should stay clear of any takeover hopes. But in making a decision to invest in a stock, it should be seen as a nice bonus rather than a priority.

READERS: Have you ever bought a cheap takeover target and profited from it?

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About the Author
Investing Reporter

David Berman has been writing about business and investing since 1995. He has written for a number of magazines, including Canadian Business and MoneySense. He worked at the Financial Post as an investing writer and daily columnist before moving to the Globe and Mail in 2008. More

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