M&A? The Party's Not Over Yet

The £22.1bn bid by US cable operator Comcast bid for Sky has a end of an era feeling to it. Maybe it’s the memory of the last big round of media company mergers (Worldcom, anyone?) or maybe it’s Warren Buffett’s recent condemnation of a ‘purchasing frenzy’ of M&A activity. Perhaps it’s just the end of the era of cheap debt. Could markets be about to lose this all-important support?

In his annual letter to Berkshire Hathaway shareholders, Buffett said that corporate buyers had become less and less price sensitive, with the result that pretty ordinary businesses were now selling at top drawer valuations. He put the blame squarely at cheap debt and macho CEOs, whom shareholders were encouraging to do deals. As he said: “it's a bit like telling your ripening teenager to be sure to have a normal sex life."

Merger and acquisition activity has been buoyant, exceeding $3 trillion for the fourth consecutive year (source: Thomson Reuters). 2017 finished with three mega-deals - CVS Health’s $69bn bid for healthcare insurer Aetna, the sale of global shopping centre business Westfield to France’s Unibail-Rodamco for $24.7bn and Rupert Murdoch’s decision to sell a chunk of 21st Century Fox to Disney for $66bn.

Rampant merger and acquisition activity has often characterised the end of a bull market. Russ Mould of AJ Bell recently noted that January was the best month for global merger and acquisition activity worldwide since 2000. These mega mergers tend to suggest companies flush with cash, who are less discerning about where they allocate capital.

At the same time, we are seeing a shift in the economic climate, and a likely tightening in monetary policy conditions across the globe. If corporate borrowing rates go up, then investors could expect some pull-back. It is difficult to know the extent to which M&A has supported markets, but it may have provided a floor for recent falls.

However, investment bankers don’t appear to be concerned. Marc Nachmann, co-head of global investment banking at Goldman Sachs, told the Financial Times that “the momentum around large deal activity would continue into next year as we see a number of industries undergoing massive strategic shifts and further consolidation.”

This is key. Merger and acquisitions are a key way for companies to defend themselves against disruption. CVS Health’s bid for healthcare insurer Aetna was fuelled by the prospect of Amazon’s entry into the pharmacy business. The Sky/Disney/Comcast deals reflect profound changes in the media and broadcasting industries in recent years. For many companies, making deals is the only way to hold back the predatory influence of Big Tech.

Then there is US tax reform, which is likely to see more corporates with more cash. The structure of the tax reform encourages US companies to repatriate large cash balances held offshore. Not all of this will go on M&A activity, but some almost certainly will. A recent report by consultancy BCG  said: “Increased corporate earnings power and quality, as well as liquidity, will create a more stimulative investment and M&A environment.” Plus “Higher earnings power will make year-end 2017 valuations look less lofty.”

However, this won’t be confined to the US. Thomsen Reuters reports more deals in Asia. Activity in the Asia-Pacific region has climbed 11% over the past year to hit $911.6bn.

While it all feels a little toppy and ‘end of cycle’, there is plenty to suggest that the M&A bonanza can continue for some time. It doesn’t mean that companies are necessarily making the best decisions, but many continue to see deal-making as the best defence against disruption.

Action Bias: What Is It and What Can You Do to Avoid It?

No matter how much work you do as an investor on researching opportunities, the biggest problem you’re likely to have is making sure you don't make silly trading mistakes.

This is why it’s important to know and understand the logic behind behavioral investing. One particular behavioral bias that we could all succumb to is action bias:

“One final aspect of the bias to action is especially noteworthy, the urge to act tends to intensify after a loss, a period of poor performance, in portfolio terms. Psychologists have asked people to consider something like the following scenario Steenland and Straathof are both coaches of soccer teams. Steenland is the coach of Blue Black, and Straathof is the coach of E.O.D. Both coaches lost their prior game with a score of 4-0. This Sunday, Steenland decides to do something: he fields three new players. Straathof decides not to change his team. This time both teams lose with the scoreline of 3-0. Who feels more regret, coach Steenland or coach Straathoff?

Participants saw this statement in one of three forms. Some saw it as presented above -- framed in terms of a prior loss; others were simply given the second half of the above with no information on prior events, and the final group saw a version in which both coaches have won the previous week but lost this week.

If the teams had one last week, then 90% of the respondents thought the coach making changes would feel more regret when the team lost this week. However, when the situation is presented as the teams losing both weeks, the coach not taking any action was thought to be feeling more regret by nearly 70% of the respondents. The logic was that "if only" the coach had made some changes, he might not have lost for a second week in a row. This highlights the role that counterfactual thinking plays in our judgments. When dealing with losses, the urge to reach for an action bias is exceptionally high.” -- James Montier, The Little Book of Behavioral Investing

Action bias is the desire to do something and it's extremely dangerous for investors. Nine times out of ten the best action for you to take as an investor is to do nothing. It's the strategy that's helped turn Warren Buffett (Trades, Portfolio) into a multi-billionaire over the years. However, most investors just cannot resist the urge to trade and it's one of the most destructive urges there is.

Trying to avoid it is not easy, then again if you know what it is, it's not hard. The first stage in avoiding action bias is just to be aware that it exists, when you know this you can take actions to make sure that you don't make the mistake.

Acknowledging that you will make mistakes, will help you put in place checks to ensure that you do not repeat them. Checklists are one way of helping. Checklists provide a speed bump that forces you to double check your actions, rethink the process and avoid acting on impulse. What's more, as humans we cannot be expected to remember every mistake and lesson we've learned. Incorporating them into a checklist as you go along will ensure that you don't forget these mistakes you've made in the past and ensure that you don't repeat them.

Another method to avoid making mistakes is to do your research. One of the points on my personal checklist is "Would I be happy if the stock fell 75%?" This is designed to force me to do my research and understand the business inside out. If I do this, then I would feel better about holding the stock if it fell 75% as I'd know more about the underlying business. Of course, this isn't a bulletproof failsafe, but it does minimize the risk of me taking action because I don't know what I've bought into. It's all about finding a process that you're comfortable with.