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investing 101Mergers and acquisitions
Aiming for a realistic return
Identifying your real risks
Putting together the right portfolio
The psychology of investing
Investing for growth
Seven questions to ask before buying a growth stock
How to spot value
Selecting stocks for income
How to buy bonds
Preferred shares: uncommon values
Convertibles: the best of both worlds
Closed-end funds: their time will come again
The right way to use stock options
Mergers and acquisitions
Frequently asked questions I
Frequently asked questions II
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Once dealmaking starts, there are ways smart individual investors can hold their own against insiders.

Takeovers and other corporate deals offer the potential for enormous profits. But these special situations are fundamentally different from other kinds of investments. If you buy shares in a successful growth company, you may be able to hold them for a decade or longer, as long as earnings keep rising. By contrast, takeovers and other corporate deals are unique events -- where most of the profit occurs in a single burst. But when it comes to capturing those gains, individuals are at a decided disadvantage against professionals who almost always have better access to M&A information.

In a takeover, the acquiring company usually has to offer a premium of anywhere from 15 percent to 50 percent for the target company's stock. As soon as a bid is announced (and sometimes before, if there's a leak), the acquirer's stock typically drops, while the target's rises.

If you own stock in the acquirer, you have to decide whether you want to be a shareholder in the new firm. Merged companies may benefit from huge cost reductions and become more dominant in their markets. But they often underperform comparable stocks for a year or more after a deal is completed because it always takes longer than expected to work out the kinks. So you should either get out at the first really good opportunity -- or be prepared to wait a while before seeing a significant payoff.

A perfect case in point is Union Pacific, the largest U.S. railroad. The company has faced enormous problems since acquiring Southern Pacific in 1996, including horrific traffic delays in Texas. Union Pacific actually posted a loss in 1998, and earnings aren't expected to reach a new high until 2001, a full five years after the merger.

If you own shares in a target company, most of your potential gains will be reflected in the share price as soon as the bid is announced. It generally makes sense to sell quickly, because the chances of losing those windfall profits are greater than the little bit extra you could make by holding on. Sprint stock initially ran up after WorldCom proposed a takeover, only to crash in July 2000 when the deal collapsed over antitrust problems.

There are situations, of course, where it makes sense to hang on through a merger. If you really believe in the combined companies' prospects, then go for it. Just be prepared to hold for at least three to five years if you have to. And in deals where a company is acquired for stock rather than cash, holding on to the target helps you avoid capital gains taxes. You don't have to pay tax until you sell the new shares -- hopefully at a big profit.

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