Q: While watching the financial news, I heard there's a rumor that a certain billionaire investor is about to buy out a specific company. How accurate do rumors like this tend to be, and is it a good idea to buy shares in anticipation?
When a rumor like this is made public, there's often some degree of truth to it. For example, maybe there have been preliminary talks between the billionaire investor and the company. So it may seem like a good idea to scoop up some shares in anticipation.
However, it's important to point out that more often than not, nothing really comes of rumors like this. For example, Bloomberg compiled data that showed at least 1,875 separate buyout rumors involving 717 companies between 2005 and 2010. How many actually got acquired? Just 104 of them -- or 14.5%.
Also, it's important to remember that buyout rumors tend to cause a stock's price to rise, so you'll pay an inflated price to bet on a takeover. The average stock in Bloomberg's data popped nearly 3% when the rumors started flying -- but came crashing back down soon after. And as I mentioned above, the takeover rumor didn't come true more than 85% of the time.
In short, it's generally a bad idea to buy a stock because something is supposedly about to occur, whether it's a buyout, strong earnings, or any other news that could send shares higher. Sticking to investing in excellent businesses with lots of long-term potential is the better way to go.