One of the most frustrating parts of trading is feeling as though you've missed an epic and perhaps very profitable rise in a company's shares. Still, instead of accepting the unfortunate reality, the urge to hop on board wrongly assuming the climb can somehow continue is the easiest and, most importantly, costliest mistake a trader can make.
Nothing can prove as a greater such lesson than the recent action in shares of Twitter (NYSE:TWTR). With Salesforce (NYSE:CRM), Disney (NYSE:DIS), and Google (NASDAQ:GOOG) (NASDAQ:GOOGL) initially rumored as potential suitors, shares rallied over 25 percent in the span of two weeks. However, when news broke that the bidding had dried up leaving the company to potentially consider a divestiture of its assets, shares plunged almost 30 percent in three days.
Now some might view the recent drop in shares as little more than an unfortunate break for those who bought high. After all, if a bid had immediately gone through from one of the aforementioned companies, shares would have gone even higher, right? Well, not exactly and here are some reasons why.
- Valuation: Along with that surge in share price came an overwhelming rise in market cap. Valued at about $9.7 billion at it's low in May, the company was worth more than $17.6 billion before reports of an exodus of bidders. Of course, this run had nothing to do with actual growth or a positive development regarding the company's infrastructure, but on mere speculation. That speculation made buying Twitter all the more unappealing and opened the possibility of even an underwater bid.
- Rushing a Sale: Twitter's announcement last week that the company wanted to conclude negotiations by its Oct. 27 earnings date should have created a sense of unease for anyone imagining that shares would continue to climb. With the stock getting rocked after ugly reports for the first two quarters of this year, it would be safe to assume that the third quarter won't be much better and the bidders and Twitter know it.
- Competition is Coming: The goal of most takeovers is to not only expand the acquirer's business and outreach, but also to buy an up-and-coming company sure to offer a noteworthy increase in growth. With Twitter, that day may have already passed. The news that Snap (Private:CHAT), the parent company of Snapchat, was considering an IPO on the same day Twitter's shares fell following an exodus of Google and Disney from the bidding table was more than just an ironic coincidence for those who did their homework.
Of course, it isn't just companies such as Twitter plagued with a challenging future that provide a warning regarding the dangers of chasing. Even stalwarts such as Amazon (NASDAQ:AMZN) can offer important lessons.
After gaining an overwhelming $400 per share in 2015, the stock led the market pullback that started this year falling more than $200 in little more than a month. Although shares eventually recovered and then continued their run, chasing could've just as easily left you with a loss as with a profit.
Overall, Twitter may eventually be bought out. Still, the odds of a premium are no greater than the odds of a more conservative offer or the odds the company has no offers at all. Thus, highlighting the risks of chasing and tampering down the expectation of a misguided and unlikely best case scenario.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.