How To Accurately Predict The Future Value Of A Stock

What if I told you that there exists an investment strategy where you can buy a stock already knowing what the price is going to be 4-6 months down the road?

Sound too good to be true? It isn't. In fact, this strategy is known and employed by thousands and thousands of sophisticated investors.

In fact, this strategy can be used on a couple of current Magic Formula® Investing (MFI) stocks today for annualized gains exceeding 14%.

What is this strategy? Let's take a look.

When A Company Loves... Another Company

Mergers and acquisitions happen all the time in the market. Usually, a larger company will offer a premium to shareholders of a smaller company that has technology, customers, products, or talent that the larger company desires.

Immediately, the stock price of that smaller company (the "acquired") shoots up to somewhere in the neighborhood of the buyout price.

However, here is where it gets interesting. In most cases, the acquired's stock price doesn't go all the way to the buyout price. There are still some risks to consider (we'll discuss those later), and a premium will remain to account for those risks.

This is where the merger arbitrage strategy can be deployed. In most cases, M&A deals take anywhere from 4-8 months to close. We know that, in most cases, deals tend to close at the announced price. Given this, we know the two most important things in investing: what a stock's price will be on a given future date. It is easy to calculate an annualized gain given the current premium to the buyout price and the distance to the buyout close date:

Total Gain Potential = (Close Price - Current Price) / Current Price
Annualized Gain Potential = (Total Gain Potential / Days To Deal Close) * 365

Really, that's about as sure a thing as you can get in stock investing.

There are a few things to consider first, however...

Merger Arbitrage Risks

The biggest risk in merger arbitrage is that of a deal falling through. When that happens, the stock price of the acquired usually tanks, as arbitrageurs exit the stock en masse, usually with sizable losses. While there are many things that can scuttle a deal, there are 3 main reasons to consider before entering an arbitrage play.

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Disclosure: Steve owns no stocks referenced ...

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