The business world's version of "retail therapy" involves shopping for entire companies, and if you happen to own shares in a company targeted for acquisition, you'll probably be fairly happy about it. Buyers, as a rule, have to offer something of a premium to get these deals done. But buyout bids of whatever size frequently offer shareholders a choice: cash or stock in the acquirer. (Not to mention that one can always sell prior to a deal's closing day, take the premium, and move on.)
In this segment of the Market Foolery podcast, a listener is seeking some advice on that decision: Is there a general rule about which path is better? Host Chris Hill and senior analyst Emily Flippen weigh the pros and cons of each course.
A full transcript follows the video.
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This video was recorded on Dec. 11, 2018.
Chris Hill: Question from Mike in Ohio. He writes, "I have two questions. I've never had a stock I own be part of a buyout. But what is the general rule of thumb if you own a company that gets bought and the stock subsequently shoots up 20% or more? Do you sell and take the profit? Or hold the stock to own shares of the new company? What are the pros and cons of each?"
Great question! I don't know that there is a general rule of thumb. This has happened to me a couple of times. It just depends. I know that's not a particularly satisfying answer. To his point, what are the pros and cons of each?
Emily Flippen: You're completely right that it depends. It also depends on the type of buyout. A lot of times, you might get a cash buyout where a company is acquiring another one and it's not rolling into shares of the new company, you're just getting cash in your brokerage account in exchange for that share. In that case, it's important to remember that's a taxable event, first of all. Whatever your cost basis is for that stock, you're going to have to pay taxes on whatever cash you receive. And, now, you have to make a decision about what to do with that extra cash. Most of the time, I think the average premium is about 25%. So, a lot of times, you as an investor are either really happy because you got a premium, or really sad because this might be a company that you loved that maybe no longer exists, at least not in the way that you've known it.
In this case, he's asking about when it's a stock buyout. The stock shoots up, and the shares that you own are going to translate into shares of a new company. That's when the decision making comes into play. You have to completely redo all your due diligence about that investment. Do you even want to own shares of that new company? In that case, you have to critically think about it, and think, "I can sell this now and roll it into a different investment, I could retain the shares of the new company." It's a personal investing decision.
The question is, when you have a stock and it shoots up 20% and you're trying to figure out what to do in that in-between period, you'll notice that a lot of times, the stock price doesn't directly go up to the entirety of the offer price. That's because there's always the risk of something falling through. So, if you want to cash in that opportunity, mitigate the risk of that buyout not happening and sell, you can do that. You can continue to hold because you love the company and you want to roll it into new shares. It really is an independent investing decision. I will just say that it's important to consider the taxable effects of whatever you're choosing to do.
Hill: It is the proverbial good problem to have.
Flippen: Yes, exactly. Well, I mean, we also see great companies that we love get bought out. I know, for example, Red Hat recently got purchased by IBM. It's a sad thing for a lot of Red Hat investors because they believed in that company, they believed in the culture, and then you have a company that has a completely different culture coming in and acquiring it. The question is, are they going to continue to do what they're known for doing, what I love that they do? And we don't know. So, it can be a great thing as an investor, you can make a lot of money, but it can also be sad as an investor because you lose companies that really hold a special place in your heart.
Chris Hill has no position in any of the stocks mentioned. Emily Flippen has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.