A Winning Stock Strategy: Sell on the Rumor

MARKETS & FINANCE
January 13, 2011, 5:00PM EST

A Winning Stock Strategy: Sell on the Rumor
Companies named as acquisition targets typically deliver disappointing returns for investors

By Tara Lachapelle

The surest way to profit from takeover speculation in the stock market is to bet it's wrong.

Bloomberg examined 1,875 rumors about pending buyouts of 717 companies from 2005 to 2010 and found a total of 104 of those companies were acquired. While stocks that were the subject of takeover speculation initially jumped, they tended to decline over ensuing weeks. An investor who sold such stocks short—selling borrowed shares in hopes of buying them back at a lower price later—would have earned average profits of 1.2 percent over the next month, an annualized gain of 14 percent.

It's a strategy John S. Orrico has used. "We see it as an opportunity to sell if we think the rumor is false or ridiculous, which in most cases" it is, says Orrico, who focuses on mergers and acquisitions at New York-based Water Island Capital, which oversees about $2.2 billion.

Opportunities to employ the strategy are increasing as the stock market climbs and merger activity picks up. The number of unconfirmed stories about possible mergers surged to 611 last year, a 71 percent increase from 2009, data compiled by Bloomberg from more than 50 news providers and brokerages show.

Stocks tracked by Bloomberg gained 2.9 percent on the day they were mentioned in a takeover story. They fell 0.2 percent, 0.6 percent, and 1.2 percent, on average, in the day, week, and month following a reported rumor. The Standard & Poor's 500-stock index rose 0.03 percent, 0.2 percent, and 0.5 percent, on average, during the same periods. That makes sense to Todd Salamone, an equity analyst at Schaeffer's Investment Research in Cincinnati, who says that by the time market chatter is publicly reported, it's been passed around trading desks via instant messages and e-mail and is usually old news. While "the rumors tend to create a pop," he says, "it's a very short-term event."

Akamai Technologies (AKAM) has been the subject of more buyout rumors than any other U.S. company since the beginning of 2005, Bloomberg research found. The provider of computing services that speed delivery of Internet content remains independent after being named 21 times. The most recent instance was Dec. 16. After rallying 1.7 percent when the speculation was reported, shares of the Cambridge (Mass.) company lost 3.8 percent in the next week, while the S&P 500 gained 1.1 percent. Spokesmen for all the companies in this story mentioned as takeover targets either declined to comment or did not respond to requests for comment.

NetList (NLST), a computer memory systems maker, rose 1.9 percent, to $5.52, when rumors were reported on Dec. 28, 2009 that Microsoft (MSFT) might buy it. The shares declined 2.2 percent a day later, 9.4 percent a week later, and 31 percent in 30 days. "NetList makes memory modules that go into servers, so Microsoft is not the type of company that would want to go and buy them," says Richard Kugele, an equity analyst at Needham & Co. "There's a difference between hardware companies and software companies, and it's just completely outside the bounds of what they do."

Even when they coincide with other bullish signals, rumors usually don't prove accurate. The volume of call options in Jefferies Group (JEF)—giving the holder the right to purchase the stock at a certain price—jumped amid unconfirmed takeover reports on Feb. 27, 2008. A deal never occurred, and Jefferies stock plummeted 3.4 percent the next day and 10 percent the next week. It had fallen a total of 20 percent 30 days later.


Some stocks are acquired after years of speculation. OSI Pharmaceuticals (OSIP) was the subject of takeover talk nine times from 2005 to 2009, and the shares slipped on eight of those occasions. The stock jumped 52 percent on Mar. 1, 2010, the day Tokyo-based Astellas Pharma said it would begin a hostile offer. There's no record of any takeover rumors in the days leading up to the announcement. Astellas bought OSI on June 9.

Many rumors are losers from the start. MetroPCS Communications (PCS), the wireless network, lost 1 percent on Sept. 21, 2009, after a news service reported chatter about a potential bid. The stock fell 34 percent over the next month and 49 percent for all of 2009, when the shares posted the fourth-biggest retreat in the S&P 500.

"The question that remains unanswered is: Where does the takeover story originate?" says Michael McCarty, managing partner at Differential Research in Austin, Tex. "It's most likely from someone who's interested in selling." Deliberately spreading false rumors may violate securities laws, especially if the intent is to sway prices, says James D. Cox, a professor at Duke University School of Law. Proving a market manipulation case is difficult, according to Peter J. Henning, a law professor at Wayne State University and a former federal prosecutor. "You might be able to see a unicorn before you see a market manipulation case established based on rumors," he says, adding that it is difficult to prove that someone started a rumor and then traded on it. "You get lots of investigations announced and very few cases brought," he says.

Overall, Bloomberg found that companies mentioned in takeover rumors were no more likely to be acquired than any other company. The safest strategy might be to avoid investing on gossip entirely. "Don't chase rumor stocks," says Michael Vogelzang, chief investment officer at Boston Advisors. "You never know where you are in the chain, whether you're the first to hear it or the last. You're just playing with fire."

The bottom line: Stocks that are the subject of takeover rumors jump, then fall, making short sales a winning strategy. Ignoring rumors works, too.

Lachapelle is a reporter for Bloomberg News.

http://www.businessweek.com/magazine/content/11_04/b4212036681349.htm?link_position=link1

Buy the rumour, sell the news goes the old adage.

Follow the market rumour

Prashant Mahesh & Nikhil Walavalkar, ET Bureau





Buy the rumour, sell the news goes the old adage. One sees this playing out in markets all the time. Share prices inch up days before a company announces its results only to correct immediately after the company declares record profits.

But recent events have shown that following rumours can prove to be quite hazardous for your financial well being. A few days ago, a leading bank’s stock saw its price tumble 3.5% during the day, on market rumours posted on a blog. Though the stock subsequently recovered with the bank denying any such thing, this has important lessons for retail investors to learn. “One of ten rumours may be true, so if you are an investor, do wait for verification before acting on the news”, says VK Sharma, head private broking & wealth management, HDFC Securities.

Get information

Today you can place orders on the broker who is sitting on a live terminal or even use the internet to trade online, and know the status of the order with every passing second. Similarly, dissemination of information has changed. In 1995, you had to rely on the newspaper or the annual report from the company for corporate information with very few having access to the internet, which was primarily used for sending e-mails only.

However, today, dissemination of information happens in nano seconds. You have wire services, websites, 24-hour television channels, blogs, corporate websites where you have a plethora of information. With the markets getting increasingly globalised, news comes from various parts of the world. The question now is: How does an investor separate the wheat from the chaff?

Types of news flows

There could be a variety of news affecting financial markets. Some could be company specific. For instance, a company wins an income-tax case in which a refund of Rs 1,000 crore is involved, which improves the cash flow of the company.

Other types of news could be macro-economic or geopolitical in nature. Take for example, Met department forecasts of rains being below normal. Such news is not specific to a company but could affect the markets.

Source of news

Follow the trail. When the news reaches you, try and identify the source of the news. If it is an official announcement, you will find it on the website of the stock exchange, where it is listed. If there is no such announcement on the exchange site, wait for the clarification from the company’s end. Large companies do come up with clarifications as soon as possible.

Investors could look for clarifications in electronic media, such as news channels and official website of the company. “In a market where many M&As are occurring, it is very easy to spread rumours. However an investors must remember that there is no free lunch”, says Sadanand Shetty, vice-president & senior fund manager, Taurus Mutual Fund.

The potential traps

There are a lot of unregulated entities who keep feeding markets with rumours, short-term and positional calls on the stock markets. If and when investors subscribe to these services, they must clearly know that these are not necessarily fundamental calls and by subscribing to these services the investor is taking a risk. These can be stock price manipulation attempts and you may be caught on the wrong side of the activity.

Also there are instances where you receive SMS’s from unknown entities giving some information about or a trading call on a stock. Be very careful before acting on the stock. Instances have been observed where volumes are created in the market, spreading information using bulk SMS service, to offload one’s position.

If you are a trader

In the short-term, markets may be affected by greed and fear, which could affect your position. So every trader needs to work with a stop loss. Besides, you should not trade a stock when adverse rumours are already floating in the market on the same. Buy on rumour and sell on news has been the norm in stock markets for a long time.

It makes sense not to act on news that has come after a long rumour mill in the market. It is likely that the impact of the development is already factored in the market price and ‘early birds’ may prefer to book their profits upon confirmation of news. In that case the stock moves contrary to the impact anticipated.

If you are an investor

As an investor you don’t have access to the company’s management at short notice. Hence whenever you invest, it is essential that you invest on the basis of company fundamentals.

If the fundamental research is right, then rumours are unlikely to affect the company and it is only a matter of time before the stock bounces back. Such temporary weakness can be used to add to your positions in the market.