Trading Tips

One Troubling Sign of a Market Top - Beware of the Buyout

December 03, 2019 Trading Tips
Trading Tips
One Troubling Sign of a Market Top - Beware of the Buyout
Show Notes

Markets often top out for a while—or go through a multi-month correction—when greed gets rampant. There are a lot of ways to look at this phenomenon. It can happen when everyday folks are suddenly interested in the stock market.

But a more important one comes from corporations themselves. Specifically, one warning of a market top occurs when there’s a record-setting buyout offer from one company to buy another.

When big companies merge, it takes big bucks to make it happen. And the acquiring company typically uses a lot of debt to make it happen. These big deals sound great in a roaring economy, when everything goes just right.

But in the real world, things don’t always go right. Taking two big companies, with their differing values and cultures, to work together will often take more time, energy, and cost more than on the clean spreadsheets prepared by analysts to justify a deal.

That’s when two companies merge. When one company is bought out by another as an investment, the danger is more acute. In that case, a buyout firm is typically based in the finance space, and may not have the operating expertise to understand how to best handle the company they’re acquiring.

That’s why the latest record-setting buyout offer from buyout firm KKR to buy Walgreens Boots Alliance is a troubling sign of a market top. 

It doesn’t mean a big crash in the market is going to happen anytime soon. But if history is any guide, it is a sign that this market has gotten ahead of itself and may be in for some poor performance going into 2020.

We’ve seen this trend before with the AOL-Time Warner merger in 2000, and even back in the 1980’s with the RJR/Nabisco merger. These record-setting buyouts saw some short-term market peaks. 

In the AOL-Time Warner deal, the combination of combining a tech company with a traditional media company was an early warning sign of the high valuations being placed on tech. The RJR/Nabisco Merger saw a food and tobacco conglomerate that had poor returns and profit margins due to high debt levels… leading to an eventual split of the two companies.

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