While Warren Buffet is best known for his buy and hold investing (“long term is forever”), his arbitrage activities have returned him over 80 percent a year. For small cap investors, the best opportunities are when takeovers are announced. Many times, after the intial rise from the announcement, the stock price will fall beneath the announced buyout price, particularly for a small cap without strong institutional backing.
This happens for many different reasons. Long time shareholders might decide to cash out when the offer is made: i.e., “take the money and run.” Those unlucky enough to be shorting a stock are going to want to cover their positions quickly. And others might just need money and sell the stock to buy a house, pay tuition, etc…. If it is not an all cash offer, some might just take the money on the table and sell before the closing of the deal.
An example at this time is SeraCare Life Sciences, a company in the health care industry. On June 23, SeraCare received an unsolicited buyout offer from MSMB Capital Management for $4.25 a share. The price of SeraCare rose to a high of $4.28 the day of the announcement.
Now SeraCare is trading for $3.88 a share, just over one week later. The buyout offer has not been rescinded. Small cap investors buying now would be looking at about a 10 percent gain for a short period of time until the buyout is consummated. Time and time again, that adds up: more than 80 percent a year for Buffett. With 2011 looking to be a record year for mergers and acquisitions activity, there will be many opportunities for this type of arbitrage on buyout plays.
There is downside protection too for the investor: even if the deal does not go through, you own a stock that someone wanted at a much higher price. The year high for SeraCare is $4.97. So buying at $3.88 still puts you well below the year high. Arbitrage offers high profit potential for small cap investors with little risk in the right situations.
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