Buyouts Can Be Big For Penny Stocks But Not In The Way You May Think
Penny stocks hold a lot of potential especially if the company is an acquisition target. You always hear the stories of how someone who found a cheap penny stock to buy that ultimately was bought out for much more than initially paid for. We’ve seen this a lot in industries like biotechnology, mining and even tech. Most recently we saw how a speculative rumor turned out to be true for Fitbit (FIT Stock Report) and Alphabet (GOOGL Stock Report).
Shares of FIT soared higher on the date the acquisition was announced. Google parent, Alphabet agreed to purchase the health analytics company for $2.1 billion. Leading up to the buyout, shares of FIT stock rallied as speculation and rumors from “those close to the situation” spread non-specific info of a proposed acquisition.
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Typically rumors of such size and scope end up as half-truths or wishful thinking. But, in this case, it ended up being a big win for investors who bought shares of Fitbit when it was deep in the penny stock range.
But the story isn’t always great for penny stocks. Before we get into more detail, let me ask you, “Why do you buy penny stocks?” The average response would be based on price and the fact you can buy a company at a discount assuming it is undervalued. Well, those companies on the acquisition trail feel the same way. But even more so as they’ll spend millions and even billions to buy up a new asset.
Penny Stocks & Acquisitions: What Happened To Diplomat Pharmacy Inc. (DPLO)?
Here’s a case of massive frustration for those who tried to play a trend with Diplomat Pharmacy (DPLO Stock Report). This was one of the top penny stocks to watch after shares plummeted in November. The biotech penny stock was trading above $6 a share before announcing terrible earnings. It also stated that it “has substantial doubt” it can continue operations. But as soon as this news was announced, rumors started to fly.
Wells Fargo analyst Jamie Stockton lowered his price target on the stock to $3 from $5.50 but maintained his rating on the stock at Market Perform. Morgan Stanley analyst Ricky Goldwasser followed a similar directive.
His rating stayed at Equal-Weight but the price target was dropped to $4 from $8. Both analysts put together buyout scenarios about the company as well. In any case, DPLO stock rallied in a major way during the weeks to follow.
In fact, as of last Friday, shares nearly reached previous levels that Diplomat stock was at before reporting earnings. That’s right, highs of $6 per share to mark a near 1-month rally of over 145%. But then it happened; Diplomat got its buyout offer.
Diplomat Pharmacy Gets Bought Out For $303 Million
That headline at first glance might get someone excited. But then we need to do what? Read between the lines and look into the fine details. A $303 million purchase means that the buyer, UnitedHealth Group’s (UNH Stock Report) OptumRx, would pick up the company for $4 a share. Thanks to the buyout, anyone owning shares between December 6 & November 21 just took a haircut.
For the rest of the day the acquisition was announced, DPLO stock traded in a tight range. This was between $3.89 and $3.98. I would agree with Baird analyst Eric Coldwell in his statement.
“It’s hard for me to call it (UnitedHealth’s offer) a godsend on a stock that has gone from over $50 to now a take-under… I would not call this a great day for Diplomat.”
Then again, this is the risk that’s taken when it comes to finding penny stocks to buy. It’s also a good lesson in understanding exactly why it’s so important to take profits as a stock rises.
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Some of the top traders in the market stand by this rule. Many of them stick to what’s known as a tiered trading strategy which involves buying and selling pieces of 1 whole position as a stock increases. This preserves capital, mitigates risk, and allows traders to stay in a winning trade longer. It also allows them to quickly cut bait on a premature breakout. Needless to say, it isn’t a shock as to why investors might be surprised at this dramatic outcome after such an acquisition.