Warren Buffett found another way to make "free money" with S&P 500 stocks, and there's still time for you to beat him to it.
Buffett is already a large owner and is adding to his position in Activision Blizzard. But that's just one of the top stocks still largely undervalued vs. pending buyout offers, says an Investor's Business Daily analysis of data from S&P Global Market Intelligence and MarketSmith. The strategy is simple: Buy the stocks now, wait for the deal to close and pocket the difference.
Buffett is on to this strategy. But his big bet is just one of the eight-largest positions with the most upside left — including VMware, Plantronics and Mandiant — inside the top ETF that targets stocks pending buyouts.
Specifically, all these stocks are below the value of their original buyout offers based on payments to shareholders. As long as the deals get done, and they most probably will, there's room for upside. The buyout prices are calculated using offer-day buyout bids of shareholder compensation and current shares outstanding, collected by S&P Global Market Intelligence.
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Looking For 'Free Money'
No wonder even Buffett is looking for easy gains. Making money this year in the S&P 500 is no easy feat. The S&P 500 is down nearly 13%. Most of Berkshire Hathaway's stocks are down this year. Fears about inflation, trade imbalances and rising interest rates depressed stocks all year.
And that's what makes betting on merger deals so alluring. Many of the buyout offers were made by some of the largest U.S. corporations during more halcyon times. Simply holding on to these stocks — until the deals are done — can be just a waiting game until you cash in.
Just look at Activision Blizzard. Buffett's Berkshire Hathaway is the No. 1 holder of the stock with 8.7% of the shares outstanding. And it's not because he's a video game fan. It's one of the few winning stocks Berkshire Hathaway is adding to this year. And it's easy to see why, especially if you're patient.
Microsoft back in January bid $72 billion for the company in total (excluding liabilities), which works out to roughly 96 a share. As long as the deal gets approved, that means there's more than 20% upside from the current price of 79.31.
At least in theory. Delays due to regulatory or shareholder approval put an element of doubt into the deal. Also, it's always possible the buyer will back out — a painful lesson Twitter investors know too well.
Merger Arb ETFs A Mixed Bag
Don't want to pick merger deals? ETFs can help you play this specialized investment Buffett seems to like. So far, though, few of these so-called merger arbitrage ETFs have delivered the explosive gains investors like to see.
"These merger arb alternatives ETFs have largely treaded water this year rather than providing a strong offset to weakened traditional equities," said Todd Rosenbluth, head of research at VettaFi.
You might think playing the merger game is an easy score. And it can be. But the merger arbitrage ETFs this year show why it's no guarantee. IQ Merger Arbitrage ETF — the largest such fund, with $559 million in assets — is down 1% this year.
The second-largest such ETF, ProShares Merger, is off 3.1% this year, while First Trust Merger Arbitrage is up just 2.7%.
Keep in mind that these ETFs buy the stocks after the buyouts are announced, typically following big jumps on the news. The stocks can fade if the stock prices overreact on the upside on the announcement or if the deal looks likely to fail or get delayed.
Shares of VMware, for example, are down 8% from the day after the buyout from Broadcom in May. They're still trading more than 20% below the buyout price of more than $60 billion (excluding liabilities).
Such ETFs highlight the promise, and the risk, of this seemingly "can't fail" approach.
"Investors that sought these out to provide an absolute boost to their portfolio have been disappointed," Rosenbluth said.
S&P 500 Stocks: Money For Nothing?
Top holdings in IQ Merger Arbitrage ETF with most upside to buyout price
| Company | Symbol | Buyout date | Buyout size (in billions, excluding liabilities) | Buyer | Gain to buyout (from current price) |
|---|---|---|---|---|---|
| VMware | 5/26/2022 | $61.2 | Broadcom | 22.1% | |
| Activision Blizzard | 1/18/2022 | $75.3 | Microsoft | 21.5% | |
| Plantronics | 3/28/2022 | $1.9 | HP | 18.8% | |
| Mandiant | 3/8/2022 | $5.9 | 9.7% | ||
| 1Life Healthcare | 7/21/2022 | $3.7 | Amazon | 9.1% | |
| Zendesk | 6/24/2022 | $10.0 | Abu Dhabi Inv. | 6.3% | |
| Nielsen Holdings | 3/29/2022 | $10.1 | Brookfield Business | 1.3% | |
| Alleghany | 3/21/2022 | $11.4 | Berkshire | 0.8% |
