When Mike Ser saw the price of Research In Motion Ltd. fall about 14 per cent in early May, he pounced on the stock.

The Toronto-based trader didn’t buy the company because he thinks it will bounce back. On the contrary, it’s the poor performance that’s attractive. The low stock price, he says, makes it ripe for a takeover.

Mr. Ser has a history of buying companies for the takeover potential. He says that between 2002 and 2004 he made a lot of money by purchasing junior mining stocks that he thought would eventually get bought out. He’d spend between $5,000 and $10,000 on a business and he’d often make three times that, if not more, on a sale.

This strategy wasn’t always successful, but he says he has made more than he lost. While he doesn’t buy for mergers and acquisitions as much as he used to, every so often he’ll revisit his old investing tricks.

Buying a company purely for the M&A play is a risky strategy, but people do it – just look at how stock prices rise on the rumour of a purchase. If you do want to play this game, the key is to buy a company before there’s any takeover talk. “You look to buy when no one wants it,” says Mr. Ser, an independent trader, investment coach and author of A Beginner’s Guide to Exchange Traded Funds.

Peter Imhof, an investment strategist with Sprott Asset Management, says that while he never buys companies just to make money on the buyout, he’s found that the businesses he likes are often scooped up.

He buys companies that are undervalued but still have solid operations and are still earning money. “If I think the valuations are cheap, then others will think it’s cheap too,” he says.

Companies that get bought out, he says, are ones that have low price-to-earnings ratios but high earnings. For example, a company with a P/E of 10 times earnings and earnings growth of 20 per cent will be attractive to buyers. “Eventually, the market will reward it with a higher multiple,” he says.

In today’s market, a lot of good businesses are trading at low valuations and, because we’re in a slow-growth economic environment, one of the only ways for companies to grow is through acquisition.

Over the past 12 months, four companies that Mr. Imhof owned have been bought up, and he expects more to come. “A lot of large caps are flush with cash,” he says. “And the smaller ones are growing more rapidly.”

Brian Huen, a managing partner with Toronto’s Red Sky Capital, has seen six of his companies sell to larger businesses over the past 12 months. But, like Mr. Imhof, he’s not buying stocks just to make money on a merger. While it’s always great when it happens – premiums can be 30 per cent or more – he, too, buys strong companies with the hope that the stock price will rise, takeover or not.

Playing the acquisition, Mr. Huen says, is risky for a number of reasons. The biggest risk is that a deal doesn’t occur and the stock price falls. It’s even more troubling if the company’s management is focused on a takeover. “You don’t want the business to be set up for a sale,” he says. “They’re just trying to make a quick buck instead of running a long-term business.”

Another issue is the still volatile economic climate, which can have a significant effect on junior mining companies. If you buy a junior miner – this sector is often a favourite for M&A speculators – and commodity prices fall, the chances of a takeover drop, too.

Whatever you do, don’t jump in on a rumour or after a takeover bid has been announced. The price almost always jumps immediately after an offer has been made, so you likely won’t get much more of a premium if that transaction does go through.

And it can be a big “if.” When BHP Billiton made a bid for Potash Corp. in August of 2010, Potash’s stock price soared from about $39 to $52 in three days. The deal didn’t happen; now the stock price is back to where it was two years ago.

Mr. Ser is hoping that his latest M&A play will result in a big payday, but he knows there are no guarantees. He says he’ll hang on to the stock for a little while longer, and will consider selling if the price drops another few dollars. But if the price stays where it is, then he’ll wait until the company gets bought out.

“RIM looks good,” he says. “Based on what I’m seeing right now I think investors will eventually get a 50-per-cent premium.”

Appeared in Globe and Mail’s May 16, 2012 issue.

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