Is Trading M&A Rumors a Sound Strategy?

Feel like gambling, but don’t want to drive all the way to the casino? Instead of sitting down at the Blackjack table, sit down at your laptop and try to figure out the next surprise M&A takeover target.

According to The Associated Press, U.S. companies, over the past few months, have announced a dozen deals worth $3 billion or more in mining, food, technology, airlines, and other industries. Stocks of the acquired companies have soared 20 percent or more following the announcement.

Billionaire, Warren Buffett and his company, Berkshire Hathaway BRK, joined with another investment firm to buy H.J. Heinz Co. HNZ for $23 billion. The deal works out to $72.50 per share or roughly 20 percent higher than the ketchup company’s share price the day before the deal was announced.

On Friday, the SEC announced that the assets of a few unnamed investors were frozen because they were “lucky enough” to purchase more than 200,000 Heinz call options the day before the announcement, according to the Post-Gazette.

The SEC routinely reviews trading logs following big announcements. In this case, these traders’ luck is about to run out.

Another notable example of shareholder luck involved the acquisition of Dell DELL by Michael Dell and an investment firm in a move designed to take the publicly traded computer company private. The sales price? $24 billion or $13.65 per share, a 25 percent premium over the pre-announcement price.

How do you find the next possible target? It’s not easy but a reasonably valued stock and a company with low debt and a history of generating lots of cash make for good candidates but even that isn’t always true. Among the current rumored takeover candidates are Kohls KSS, Chesapeake Energy CHK, and City National CYN.

But as gamblers know, the bet can and often does, go against them. In May 2012, pharmaceutical company Warner Chillcot’s WCRX stock spiked 43 percent on rumors that it was a takeover target. Later, when the company announced that it wasn’t interested, the stock lost half of its value.

Those who prefer a little more stability may want to check out the IndexIQ Merger Arbitrage ETF. MNA

MNA is home to companies for which there has been a public announcement of a takeover by an acquirer. This is not an ETF that allows investors to play the rumor mill.