As an individual investor, does it always make sense to sell a stock that's gone up due to a merger announcement?
Suppose I hold a stock that's recently had a run-up because another company has made a bid to acquire it. It seems like I should almost always sell the stock in this case, because there are only a couple different possible outcomes:
1) The merger goes through, and I make a few pennies more (the spread between the current price and the announced takeover price)
2) The merger falls through, and the stock drops significantly.
On average, the likelihood of these two possibilities will be fairly reflected in the stock price due to people who practice merger arbitrage strategies. So as an individual investor, I should be pretty much indifferent over the long run. But in the short run, the possibility of (2) hugely increases my volatility.
So does it almost always make sense to sell if the spread between the announced takeover price and the current trading price is small?
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Factors to consider:
I would expect the new stock price to properly reflect some of the volatility of your case (2) as well as the simple expected likelihood of the merger going through, but admit I haven't read anything on it.
Given (1), if the acquiror's offer is all cash, then yes, you might as well free up your capital immediately. (The only reason you might not would be if you are so enamored of your original purchase that see real value in the possibility that the merger fails and you have your original investment again.)
If, however, the acquiror's offer is for stock, you have two other factors to consider
Your view of the merged entity as an investment. If you're not comfortable with the combination of acquiror and your existing holding, prefer selling.
The tax effect of selling. If you have an unrealized gain, prefer holding; selling will cost you the gains tax, whereas holding the new company triggers no taxable event.
If you have enough experience and information to make a reasonable guess as to the likelihood of (1), then it makes sense to hold, generally speaking.
If it were ME, and I didn't have much experience or knowledge on the specific companies involved, I'd probably take the gain.
But that's just what I would do, based on the isolated and limited info you provided. Reality is probably a lot more complicated.
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