A reasonably reliable method of profiting in the stock market is by focusing on mergers and acquisitions (M&A) and by buying the stock of the company that is about to be acquired. The purchasing firm generally pays a premium to the market price resulting in a corresponding percentage rise in the market price itself. This gives you a quick profit of a few percentage points, at which time you exit the trade. The difficult part in this strategy is the uncertainly associated with identifying companies that are takeover targets, and then assessing when such a takeover might happen. Also, what is the premium that any offer from a potential suitor might carry? Can this become a serious wealth building strategy?

Any serious wealth builder should focus on a few select strategies, and the mergers and acquisitions strategy could be one such strategy. To ferret out opportunities, focus on news related to this category through newspapers such as Investor's Business Daily and Wall Street Journal. M&A activities tend to rise when the economy has been doing well for a few years, and the stock market valuations approach a high point. Also, availability of credit has to be relatively easy - otherwise the cost of capital becomes prohibitively high to do a deal. It is important to keep these background considerations when taking into account the likelihood of any deal and in choosing likely candidates.

The best upside in mergers and acquisitions trades is when a large firm buys a much smaller, but public firm. Large companies tend to fill holes in their overall solutions portfolio through acquisitions and often are willing to offer a substantial premium to ensure that the purchase goes through smoothly and goes over well with the shareholders of the smaller firm. Moreover, larger firms have the extra cash or strong stock to make good on the offer - especially given the relatively small size of the firm being acquired.

To overcome the difficulty of anticipating when a firm might be acquired, it is critical to choose to invest in those companies that are successful already. It is somewhat difficult to find successful small companies that are reasonably priced, and hence it becomes important to also specialize in small-cap value investing. Some of these companies get acquired during a down-swing in their prices, as their price makes them extremely attractive takeover targets. Thus in brief, invest in successful small-cap firms that are reasonably priced, and whose solutions fill a gap in the portfolio of some large, successful firms. Ensure that these larger firms do indeed buy smaller firms - for a firm is no more than the sum total of the philosophy by which it lives.

The above obviously implies that we are not fans of large company mergers and seeking to profit through those activities. While these activities are excellent for investment bankers and other large Wall Street financial houses, these are not such great candidates for making serious profits for the average trader. While large deals do happen reasonably frequently, the amount of premium being paid, the difficulty in getting shareholder approval, the uncertainty over the resulting benefits of the merger and so on make for great news stories, but mediocre trades. On an average, focusing on the marriage of a large firm with a much smaller firm proves more profitable.

The worst type of merger and acquisition activity is when a company tries to diversify its business activities into completely new areas by acquiring a new company in that space. The result is "di-worseification" as defined by Peter Lynch. Perhaps as an investor you should not care about the net result of such mergers, since you be long done with the trade by then. However, it is our opinion that the path to the best profits are when two companies align in their interests - suddenly all forces work together to make the deal happen and deliver profits to you. It is always better to invest in trades that also make business sense.

Use this link to find a list of resources that talk about mergers and acquisitions.