Tuesday, May 1, 2012

Sell the rumor

Yesterday was a great day for one of my co-workers...and for me as well.  I still have the magic touch.  My co-worker is a rather unique character who has way too much energy.  Actually, I'm a tad jealous of his energy levels.  He does enjoy talking about stocks and business, which are a couple of my favorite subjects, so I'll cut him some slack.  His strategy that seems to have worked well for him over the years is contrarian investing.  It is a good strategy if you know what you are doing, but as with any strategy it takes experience, knowledge, and luck.  I think it is a emotionally taxing stock strategy because you are buying what everyone is selling.  Or selling whatever everyone is buying.  This typically means that you will probably second guess yourself.  Constantly thinking...I wish I didn't buy that...or I wish I didn't sell that so soon.


Yesterday he came to my cube and let me know that he had bought Monster Beverage Corp (MNST), and they had a situation.

5 day chart Apr. 26, 2012
Monster went up 24% due to a rumor that Coke (KO) was going to purchase the company.  I told him to sell right away.  I think he might have thought I was joking at first (I'm very sarcastic, I try to avoid this in my writing).  He was hesitant.  I said, "You always sell the rumor!"  As he hemmed and hawed about what I said...every 5 second the stock price would drop 1%.  Finally I asked him...who has been the stockbroker?  Go do it!


He left, and came back after a few minutes letting me know he sold the shares and made 17%.  Later that same day Coke announced that it would not be buying the company.  The stock closed around previous levels.


Here is why you sell the rumor.  If the rumor is true, the price/value is probably already reflected in the stock price.  Therefore no further gains can be obtained.  In fact, if Coke would put a tender offer...usually the share price will stay the same until the deal is finalized.  Some arbitrage can take place during this time as well, but it is usually a small window.  This means that your stock is tied up with no further gains to be realized.  If you sell, then you have the opportunity to use your money on something more productive.


Another reason is if the rumor isn't true, you lost out on a huge opportunity.  This is the difference between realized return and expected return...kinda like the bird in the hand theory.  Sometimes these events are nothing more than luck.  So when lady luck smiles on you, take it!  Never feel bad about not making more money if you sold early especially on a rumor.  Because the situation is much worse if you are wrong.  17% in one day can be a lot of money.  If you invested $10,000...then that is $1,700.  If I could make that every day, life would be a tad different for me.

Another example is when Microsoft Corp (MSFT) was going to purchase Yahoo! Inc. (YHOO)  This is when Yahoo! was around $30 per share.  Now it is selling for 15-16 range. 


Hope and dreams are good for people who want to take action.  Otherwise your hope that the rumor comes true, or dreaming about the possibilities ends up being nothing but smoke and mirrors.


Disclosure:  Military Millionaire current does not own any shares mentioned in this article.

3 comments:

  1. You gave your friend good advice. Fortunately he followed the advice!

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  2. I always thought that you should keep waiting to see if it goes up even more if the rumor is true. It never occurred to me that you would want to sell on a rumor. Your reasoning makes sense. Thanks for sharing.

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    1. From my experience, many times even if the rumor is true...the stock still under performs. Some of the reason why is...corporate culture clash and overpayment from the merging company. A couple examples of each is...AT&T at one time purchased NCR. They paid way too much money, destroyed the brand name of NCR, and then ended up selling the company and restoring NCR's name. Another example of overpaying is when Boston Scientific bought Guidant. You can read an article http://money.cnn.com/magazines/fortune/fortune_archive/2006/10/16/8390284/index.htm. The news called it the second worst deal ever. Rumors of mergers are a great way to take your money and run. Let someone else deal with the problems.

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