Zacks Investment Research just upgraded electric generating company NV Energy, Inc. (NYSE:NVE) to its top rating: "Zacks Rank #1: (Strong Buy)." A few months ago, that would have been an awesome call. But in this case, Zacks is way late to the party on this particular upgrade, and it showcases a danger inherent in relying too much on what appears to be a computerized decision-making algorithm.
The reason is simple: NV Energy, Inc. (NYSE:NVE) is on track to be bought out by Warren Buffett's Berkshire Hathaway Inc. (NYSE:BRK.A), with a target closing date in the first quarter of 2014. That buyout has been public knowledge since May, and NV Energy, Inc. (NYSE:NVE)'s stock has already leaped to take out most of the expected value from the acquisition.
Strong buy = 3% returns? Berkshire Hathaway Inc. (NYSE:BRK.A)'s acquisition price for NV Energy, Inc. (NYSE:NVE) is $23.75 per share, paid in cash. NV Energy, Inc. (NYSE:NVE) closed on Monday at $23.59 per share, and it currently pays a $0.19-per-share per quarter dividend. Assuming it keeps its dividend steady until the Berkshire Hathaway Inc. (NYSE:BRK.A) takeover, shareholders can expect somewhere between $0.28 and $0.57 in total dividends.
Adding those dividends to the target purchase price gives a total value of $24.32 to be realized over the next eight or so months. With a starting price of $23.59, that works out to a total return of around 3.1%. That's before taxes, and the capital gains (if any are to be had after commissions) will be short-term for anyone buying now, if the acquisition closes on time.
From the looks of Zacks' upgrade, it's probably using an entirely automated rating system that doesn't know how to factor in acquisitions. It's true that investors following Zacks "Strong Buy" recommendation could get a return that pays better than an eight-month CD at the moment. Still, that 3.1% is about the maximum likely upside potential on the investment, and it depends both on the acquisition closing as expected and the company keeping its dividend until the acquisition closes.
Perhaps even worse, if the acquisition doesn't close for some reason, there's plenty of downside potential in NV Energy, Inc. (NYSE:NVE)'s stock. The stock closed at $19.28 just prior to the acquisition announcement. If, for some reason, the acquisition falls through, there's a very real chance that the stock could fall back to around that level. Starting from Monday's close of $23.59, that's a worse than 18% drop! While chances are good that the acquisition will close as expected, that's a substantial downside risk for what at this point is a pretty small gain.
Note that the downside risk is there because Berkshire Hathaway Inc. (NYSE:BRK.A) offered to pay a 20%-plus premium over the market price for NV Energy, Inc. (NYSE:NVE) prior to the announcement. That much of a premium may seem out of character for the value-focused Buffett, but in reality, it makes sense to Berkshire Hathaway Inc. (NYSE:BRK.A).