An activist shareholder attempts to gain control of a company in order to pressure its management into making changes or replace its management outright.

American billionaire investor Carl Icahn is a well-known name among activist shareholders. He is known for buying large amounts of a company's stock and then pressuring the company to make significant changes in order to increase the stock's value.

Key Takeaways

  • Activist investors can force change, for better or for worse.
  • They can buy or sell their stakes without warning, catching small investors by surprise.
  • They're not always right.

This sounds like a good thing for shareholders, but it isn't always. Here are some potential pros and cons to individual investors of having an activist investor involved.

Potential Advantages to Activist Involvement

They Get Attention

An investor who owns a few hundred or even a few thousand shares doesn't have much pull with management. Activist investors purchase (or short) a large enough percentage of a company's shares to demand and get attention. They also get a fair amount of media attention and use it to air their grievances.

The company's management and its board can't ignore an activist.

Activists have the power to hold management's feet to the fire and demand results. They will work hard to enhance stakeholder value.

New Faces Mean New Ideas

Activist investors may have sound ideas about how management can use the company's assets better, improve its operations, or enhance shareholder value.

Management may or may not be receptive to such ideas. However, the dialog could be productive of positive changes for the individual investor as well as the activist.

Demand for the Shares Could Rise

Activists tend to snap up a big percentage of a company's outstanding stock over a short period of time. Others will jump on the bandwagon in hopes of turning a tidy profit. This will push the stock price up and, by extension, benefit common shareholders in the short run.

They May Get Results

Activists usually have very specific demands. As an example, in 2006, Trian Partners pushed for fast-food chain Wendy's (NYSE:WEN) to spin off its Tim Hortons (NYSE:THI) donut business to increase value. Some shareholders bought into the idea and the board agreed. The spin-off allowed Wendy's to focus more on its core business and on competing with its rivals, including Burger King (NYSE:BKC) and McDonalds (NYSE:MCD).

Potential Downsides to Activist Involvement

It Can End Badly

When activists purchase large blocks of stock, the share price usually increases. If the activist decides it's time to unload the shares, it can drop fast, catching smaller investors unprepared.

Don't forget that activist investors act in their own interests, not yours.

Activists Look Out for Themselves

Activists try to convince other shareholders and the media to buy into their agenda, but at the end of the day they are looking out primarily for their own best interests. It would be wise for investors big and small to keep this possibility in mind when listening to an activist.

Activists Aren't Always Right

Many perceive activists as being smarter than the average investor. They have extensive experience, important industry contacts, and access to solid research.

However, activists aren't always right. Their timing can be off and they can and do sometimes lose money. At other times, their good ideas can take an extraordinarily long time to pan out. They can afford to wait it out.

Investors should keep this in mind when tempted to copy an activist's buying or selling action.

Activists May Have a Different Investment Horizon

Activists can be a fickle bunch. They may latch onto a position and hold it for years. If they can't win a board seat or persuade the company to accept their agendas, they may bail at the drop of a hat.

In short, it's important to note that activists may have a very different investment horizon from the average investor. And, they may be far more willing and able to accept a loss on their bets.