Bank-Buyout Gamblers Stay in the Game

Not surprisingly, shares of Sovereign weren't taking part Wednesday in the regional bank stock rally. The bank's stock was down 11 cents to $20.40. In November, the stock had risen to almost $25 a share on the buyout speculation.

Most say the only surefire way to play buyout roulette is to put bets on a basket of between 10 and 20 bank stocks.

"It is very difficult to use a rifle-shot approach to buying bank stocks in anticipation of them being acquired," says RBC Capital Markets analyst Gerard Cassidy. "But we agree [with] the basket approach."

In putting together a basket of buyout candidates, Cassidy recommends looking for regional banks that have a dominant market share in their geographic area. When big banks go shopping they tend to look for small lenders that are big players in a little pond.

Sophisticated hedge funds that specialize in buyout speculation use a similar approach to making their bets. But hedge fund also minimize their losses by setting up a counter-balancing short position in a related sector index.

Most experts also say the worst day to go shopping for a basket of buyout candidates is in the immediate aftermath of a merger announcement. The instant pop many potential buyout candidates get is often short lived. Investors looking to buy a basket of buyout candidates would do best to wait for a few days after the dust has settled on the latest merger announcement.

"You don't want to buy into strength," says Timothy Ghriskey, president of Solaris Asset Management, a Connecticut hedge fund. "You want to let the rumors subside."

Ghriskey says he's not a big fan of speculating on merger candidates. He says the possibility of a company being a buyout candidate is merely "icing on the cake" for him. If he's going to invest in a company, it's because it has good fundamentals behind it.

"There has to be a reason to invest in the company first," Ghriskey says. "If there is the potential for a takeover, that could add to the story."

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