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Chapter 10. Mergers and Returns: The Acquisitive Company

Chapter 10. Mergers and Returns: The Acquisitive Company

The Hare and the Tortoise Revisited

Peter was an impatient man. His portfolio was full of solid stocks that grew slowly but steadily every year and delivered decent returns, but Peter was not satisfied. As he scanned the journal for news about the stocks he owned, he noticed that the companies that made the news every day were the ones that grew through acquisitions. Led by CEOs who were larger than life, these companies grew at exponential rates by gobbling up their competition and embarking into new and different businesses. Reading about these acquisitions, Peter was struck by how much analysts liked these companies and their dynamic strategies. Tired of the staid management of the companies in which he owned stock, Peter sold off all his existing investments and invested heavily in the acquisitive companies that made the news.

For a few months, his strategy looked like it was paying off. The companies continued to post striking growth rates in revenues and earnings, and their stock prices outpaced the market as analysts continued to reward them with strong buy recommendations. The troubles began with a news story about an accounting restatement at one of the companies; its acquisitions, it turned out, had not been properly accounted for, and the earnings of the company from previous years were adjusted downwards. Not surprisingly, its stock price fell, but it was the ripple effect on the other companies that hurt Peter's portfolio. Many of the other companies in his portfolio had used the same accounting techniques as the company in trouble, and rumors of accounting troubles filled the air. As the stock prices in these companies plummeted, the CEOs went from heroes to villains, and the analysts who until very recently had been so optimistic about these companies turned on them with a vengeance. Peter, sadder and wiser from the experience, sold his stocks and put his money back into boring companies.

Moral: Slow and steady beats growth in haste.


Growth does not come easily to companies. For a firm to grow rapidly, it has to not only find a large number of new investments but these investments have to pay off quickly. Firms that are in a hurry to grow do not want to wait for this payoff to occur. Instead, they try to grow by acquiring other companies. Since they can fund these acquisitions by issuing new stock, there is no real limit (other than what the market will bear) on how many acquisitions these firms can make or how quickly they can grow, especially in buoyant markets. Small companies adopting this strategy can very quickly become large companies, and in the process, may make their investors wealthy.


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