Our investment advice on how to respond when you own a takeover stock

When you own a stock that’s being taken over, our investment advice is that it generally pays to hang on and wait for the deal to go through, then submit your shares to whoever’s making the takeover bid. Selling early will cost you money in the long run.

Weeks before a takeover is announced, speculators usually buy the stock on rumours, and drive up its price. (Mind you, speculators also drive up prices of stocks that are falsely rumoured to be takeover candidates.)

Investment advice: Patience is the key to takeover profits

When takeover speculators guess right, they are apt to take their profits early, and go on to other ventures. This depresses the price of the stock that’s getting taken over, until the actual takeover occurs.

When speculators sell after a takeover is announced, but before it goes through, they will often explain that they “aren’t greedy,” and that they “want to leave something on the table for the next investor.” Sometimes, of course, they simply want to free up their capital to chase after some other rumoured takeover. But their motives don’t matter.

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Because of this premature selling, stocks headed for a takeover often trade anywhere from 1% to 5% below the takeover price. But by following our investment advice and hanging on for another month or two, you can “earn” this extra 1% to 5%, and in many cases avoid paying brokerage commissions.

That may not sound like much, at least to many speculators. But successful investors recognize that earning a couple of percentage points in a month, and avoiding a commission to boot, is the same as earning perhaps 40% in a year.

Investment advice: How you can benefit from a failed takeover (or why Potash Corp. investors should thank Ottawa)

By holding on, you take the risk that the takeover will fall through. But that’s an easy risk to accept. That’s because if a takeover target is worth a certain amount now, it will probably be worth that much or more to another buyer in the future.

If a takeover falls through and the takeover target’s share price falls several dollars, many successful investors would see it as a low-risk opportunity to buy more.

Potash Corp. of Saskatchewan (symbol POT on Toronto), one of the stocks we analyze in our Successful Investor newsletter, provides an example of a failed takeover that has benefited investors.

The company had been the target of a hostile, $43.33-a-share takeover offer from international mining giant BHP Billiton Ltd. However, on November 3, 2010, the Canadian federal government blocked takeover under the Investment Canada Act.

At the time, Potash Corp. was trading at $48.74 a share (all per-share amounts adjusted for a 3-for-1 split in February 2011). Since the deal was blocked, Potash shares have jumped 8.6%, and now trade at around $52.93. That’s 22.2% higher than BHP Billiton’s takeover offer.

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