Comfort Zone Investing: M&A: Good News ... or Bad?

Certainly one of the good attributes, especially if you own the companies that are being bought, is that the price of the stock goes up. You can sell your stock for more today than you could a few days ago.

That leads to the next good part: investors (including management of the acquired companies) will have money to re-invest into the stock market or to buy goods or services. New liquidity, provided by the purchase, might loosen the purse strings of some of the holders, creating a little more demand in the economy. The same is true for stocks as investors look to replace a hole in their portfolios.

Another positive: corporations are starting to use the money they've accumulated. As mentioned in last week's column, if money provided by the Fed isn't used, it doesn't help the economy grow. With corporations spending billions, that money will flow into the pockets of investors who will most likely spend it, either on investments or goods and services.

Another one: when companies are willing to buy, it usually means valuations are attractive, that companies being bought are bargains. If they aren't, they are strategically important. But most M & A deals happen because the buyer's management think the acquired company will help earnings. The purchase price is a bargain compared to the stream of earnings that will follow. That suggests to investors that they should also be looking, that the time may be opportune to add to positions or start new ones, especially in sectors that are seeing the most M & A activity.

Wall Street is usually involved in these deals. And the fees are huge, always in the millions of dollars. That helps keep employment high on the Street as well as real estate prices in Manhattan. Is that good or bad? No comment.

One thing that is bad: look for layoffs in the companies that are bought. Usually the acquiring company wants to save money, especially when areas overlap, such as selling, general and administrative. If you work in one of the support divisions, say accounting, you may find yourself looking for another job. The acquiring company will most likely have a full accounting staff, able to incorporate the new duties. While this isn't always true, most M & A deals are followed by some job cuts, and most of those come from the acquired company.

Another negative aspect: competition is removed. While some of the above transactions are being made outside the buyer's markets, most M & A deals are done with a competitor. In this weakened economy, many large firms look to consolidate the industry and eliminate some of their competition (they can't eliminate all of it since that would go against the anti-trust laws). With competition lessened, it gives the surviving entity better pricing power and more marketing muscle. That usually translates into higher prices for consumers.

There are other aspects of M & A but these are ones that stand out for their significance. Investors should see them as good, especially if they own the stock of the acquired company. The economy, between the positive of the turnover of money, the new demand for stocks, goods and services and the negative of fewer jobs and less competition, may feel it as a wash. In general, at least for now, the balance would have to be tipped in the favor of good since all that money is starting to flow.

Ted Allrich is the founder of The Online Investor, chairman of the board of Bank of Internet USA, as well as the author of the book Comfort Zone Investing: Build Wealth and Sleep Well at Night. In this weekly column, he offers advice to investors who are just getting started.