Decoding the Stock Market Impact of 'Mergers of Equals’

When big companies join forces, it doesn't always lead to success in the stock market. In fact, studies show that mergers where both companies are similar in size often result in underperforming stocks.

These kinds of mergers, called "mergers of equals," usually happen within the same industry. Think finance, energy, consumer goods, and healthcare. But despite some recent buzz about mergers, overall, there haven't been as many deals happening lately. Experts blame this on a slower US economy and uncertainty about interest rates and regulations.

Now, you might think that merging with a similar-sized company is less risky for management. But that's not always true. Sometimes these deals take a long time to go through, like the planned merger of JetBlue Airways and Spirit Airlines. And over the past two decades, statistics show that the stock prices of companies making these kinds of deals tend to fall behind their industry peers by more than 7% over the next two years.

So why do companies still go for these mergers? Well, they might hope for benefits like better pricing power, chances to sell more products, or cost savings. But here's the thing: most of these mergers involve medium or small-sized companies, not the big players. And it's more likely that a company with lower-quality performance will go for a merger of equals than a top-notch performer.

The stock market's reaction to these mergers in the first week can tell us a lot. If it's negative, the merged company's stock tends to keep underperforming compared to its industry peers for the next two years. But if the market reacts positively, there's no guarantee of extra returns.

For companies thinking about merging or investors considering buying the acquirer's shares, there are three key things to keep in mind. First, high-quality companies shouldn't merge as often because they might lose their edge. Second, companies with shaky finances tend to do worse after mergers. And third, if a company is too different from its peers, the promised benefits of merging might not pan out.

In short, merging with a similar-sized company might not be as great as it seems. It's important for companies and investors to look closely at the risks before jumping into these deals.