From time to time I get emails about an announcement of a buyback, merger or a policy change with a question if it’s a good idea to invest in that particular stock or sector.
In general, I avoid taking decisions like this and I have a few simple reasons for that.
1. The event is already priced in: If you find out about something from a mainstream news media source which millions of people have access to then they will already act on that information and jack up the price.
I think infrastructure stocks and mutual funds from a few years ago are a good example of this. Everyone was convinced about the infrastructure story, and they were constantly mentioned in the media. How could people not buy into it? But if you look at their track record – they’ve done as badly if not worse than other sectors.
If you’re doing what everyone else is doing – where is the edge in that?
2. I may not fully understand the offer or policy change: This happens a lot in buyback offers where it’s easy to miss a detail like the buyback will only be a limited percentage of the shares outstanding so not everyone’s offer will be exercised or that the promoters will buy the shares from the exchange and not from shareholders, or in some cases they simply announce that they will carry out a buyback but later on change their mind!
If you don’t fully understand these things then it’s better to stay away from such offers. Do you really back yourself to play a game whose rules you don’t fully understand?
3. This strategy seems penny wise and pound foolish to me: Normally, you can’t expect a lot of gain from these kind of things – maybe 5% or so and to make that count you have to put in a large sum of money in the investment. Listing gains on stocks and bonds is a good example of this. The trouble with this kind of strategy is that while you do make money from time to time – one bad loss can wipe out all the gains you’ve made in the last year. This doesn’t appeal to me at all – it consumes a lot of time and effort but the risk – reward ratio is often skewed against you. While this kind of punting may be rewarding for brokers and traders who are glued to the market and have some sort of an edge as far as information is concerned – I don’t see how a regular retail investor can consistently make money doing these things.
These are some simple things that have guided my decision making over the years, and I don’t see it changing anytime in the near future. I know this is boring, but I’m happy seeking excitement in other areas of my life and leaving investments boring.
This post is slightly adapted from a comment in The Suggest a Topic page.