Rumour Mongering

Peter Hodson, CFA

Rumours, as they say in the stock market, are a dime a dozen. Having been involved in the stock market for more than 25 years, I can tell you that statement is no longer true. Before the internet, yes; however post-Internet a dime a dozen is way too expensive. These days, stock market rumours are more like a dime a hundred-dozen.

Individual investors can sometimes get excited by rumours, particularly takeover rumours. Visions of a quick takeover premium—or, better yet—a takeover battle—seem to ignite the flames of passion in individual investors. However, as you may have discovered yourself, following rumours usually just leaves you burned.

Most takeover rumours have some basis in fact. Take a hot sector—cloud computing for example—find a company in the sector that is growing fast, and it easy to see why it might often makes sense for a large company to buy the faster-growing smaller company. If there has been a previous takeover in the space, then investors just might believe any takeover rumour they hear.

If you are interested in ‘investing’ in takeover rumours, then it probably makes sense to look at a 2011 Bloomberg study on the topic. According to Bloomberg, the surest way to profit from takeover speculation is to bet that it’s wrong.

Bloomberg studied 1,875 takeover rumours about potential buyouts of 717 companies in the five years between 2005 and 2010. While most of the rumoured takeout companies initially jumped 2.9%, they on average fell 1.2% during the following month. Shorting the rumoured companies, thusly, resulted in an annualized gain of 14%.

So, doing the opposite to the rumour resulted in a gain far higher than what you would have received by simply going long the market.

Why do investors, then, continue to chase rumours? Well, usually it is because once in a while, they do come true. Like a lottery, every once in a while someone wins big. Even rarer, sometimes investors get a real good shot at making some money from a rumour. I remember well the takeover of ATI Technologies in Canada in 2006. Like most takeovers, this one occurred on a Monday. ATI shareholders enjoyed a 43% takeover premium. If you were paying attention on the prior Friday, however, you could have made a nice pass. A major media outlet on Friday effectively announced the deal prior to the market close. It quoted the price, the buyer and the timing. Sellers of stock on Friday were none too pleased if they were not aware of the web posting.

Clearly, a rumour posted on a major media website might have more validity than one posted on an internet stock chat line. Still, you might be surprised. I have seen major newspapers publish articles on ‘impending’ takeovers on dozens of companies. Yet I am still watching for the corporate press release on any takeover some years later.

Where do these takeover stories originate? Just about anywhere. The Internet, a trading desk, a bar—you name it. Of course, deliberately spreading false rumours would violate many securities laws; however investigations into these types of matters have been extremely difficult to prove.

As an investor, what should your strategy be? Here’s my advice: Buy good companies. If they are truly good, one day another company might buy them out at a nice premium. If not, well, you still have a good company. Just add takeover rumours to the rest of the background noise that makes life difficult for the individual investor.

Peter Hodson, CFA, Editor
Canadian MoneySaver Magazine