The Sign You're a Great Investor

What a quarter, huh?

Some $62 billion worth of merger activity was announced over the past few weeks. US Airways wants to buy Delta, Nasdaq (Nasdaq: NDAQ  ) wants to buy the London Stock Exchange, Equity Office Partners (NYSE: EOP  ) is being taken out by the Blackstone Group, Freeport-McMoran (NYSE: FCX  ) is buying Phelps Dodge (NYSE: PD  ) , and Bank of America (NYSE: BAC  ) is taking U.S. Trust off Schwab's (Nasdaq: SCHW  ) hands.

But that's not the half of it.

Large companies such as Sprint (NYSE: S  ) , Hilton, and Lennar are getting caught up in buyout speculation. And Motley Fool Hidden Gems recommendation Ameristar Casinos' stock surged more than 10% on buyout rumors after its CEO -- and controlling shareholder -- unexpectedly died (a series of events that made for some uncomfortable headlines).

There's a lot that can be said about an M&A spree like this one. Unfortunately, not enough is said about what this means for the individual investor.

So, here I go
Buyouts are bittersweet for individual investors. The good is that you make money. Most companies usually get bought out at nice premiums to current market value.

And there certainly is a lot to say for making money. After all, that's why we're invested in the first place.

There is, however, a lot of bad for individual investors when it comes to buyouts. First, you don't really have a choice as to when the buyout will occur. That means you might get hit with a hefty tax bill depending on when you bought shares.

Second, although buyouts will make you a little bit of money in the short term, they're probably costing you substantially more money over the long term. Think about it. A company would not buy another company unless it strongly believed that it could get a great return on its hefty investment. That great return is what you're forgoing when you get bought out.

Finally, a buyout forces your hand. It gives you your cash back and forces you to find another idea -- that may or may not be as good as the idea that got bought out.

Here's an example
A little more than a year ago, I purchased shares of Fairmont Hotels & Resorts. The stock was another of our Hidden Gems small-cap recommendations, and one that I believed was substantially undervalued based on its vast real estate holdings.

A few months later, the company announced that it was being acquired by Kingdom Holding for $45 per share. The stock surged, and I made a quick 40% gain.

But.

  1. I had to pay short-term capital gains taxes.
  2. I believed Fairmont was still being undervalued at $45.
  3. I didn't immediately have another place to put the money.

Unfortunately, what I thought would be a great long-term investment turned out to be pretty paltry in the scheme of things.

Here's the really good part about buyouts
That said, there's something really nice about having your stocks constantly bought out: It means you're a good investor. In fact, it may mean you're a great investor.

Because if your stocks keep getting bought out, it means you're regularly finding the two most important ingredients of successful investments: Good companies at good prices.

When you keep finding good companies at good prices, some will get bought out. Others, however, won't, and those will go on to be the home run stocks that make you serious money in the stock market.

At Hidden Gems, we're sad to say that we've now had six companies get bought out. We believe that each of these could have gone on to be big long-term winners. That said, our portfolio is still chock-full of more than 40 small companies that have not been bought out and that have already put us more than 23 percentage points ahead of the market's return.

These are great companies, and many of them remain at great prices. If you'd like to see what they are, read our research, and check out our returns, click here to join Hidden Gems free for 30 days. There is no obligation to subscribe.

Tim Hanson does not own shares of any company mentioned. Bank of America is an Income Investor recommendation. Schwab is a Stock Advisor pick. The Fool's disclosure policy takes it to the end of the line.


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