Areas of Opportunity for Value Investors: Catalysts

Owning securities with catalysts for value realization 


The attraction of some value investments is simple and straightforward: ongoing, profitable, and growing businesses with share prices considerably below conservatively appraised underlying value. 

• Ordinarily, however, the simpler the analysis and steeper the discount, the more obvious the bargain becomes to other investors. 
• The securities of high-return businesses therefore reach compelling levels of undervaluation only infrequently. 

Usually investors have to work harder and dig deeper to find undervalued opportunities, either by ferreting out hidden value or by comprehending a complex situation. 

Once a security is purchased at a discount from underlying value, shareholders can benefit immediately

• if the stock price rises to better reflect underlying value or 
• if an event occurs that causes that value to be realized by shareholders. 

Such an event eliminates investors' dependence on market forces for investment profits.

• By precipitating the realization of underlying value, moreover, such an event considerably enhances investors' margin of safety. 

I refer to such events as catalysts. 

• Some catalysts for the realization of underlying value exist at the discretion of a company's management and board of directors. The decision to sell out or liquidate, for example, is made internally. 
• Other catalysts are external and often relate to the voting control of a company's stock. Control of the majority of a company's stock typically allows the holder to elect the majority of the board of directors.  Thus accumulation of stock leading to voting control, or simply management's fear that this might happen, could lead to steps being taken by a company that cause its share price to more fully reflect underlying value. 

Catalysts vary in their potency. 

• The orderly sale or liquidation of a business leads to total value realization. 
• Corporate spinoffs, share buybacks, recapitalizations, and major asset sales usually bring about only partial value realization. 
• The emergence of a company from bankruptcy serves as a catalyst for creditors.  Holders of senior debt securities, for example, typically receive cash, debt instruments, and/or equity securities in the reorganized entity in satisfaction of their claims. The total market value of these distributions is likely to be higher than the market value of the bankrupt debt; securities in the reorganized company will typically be more liquid and avoid most of the stigma and uncertainty of bankruptcy and thus trade at higher multiples.  Moreover, committees of creditors will have participated in determining the capital structure of the reorganized firm, seeking to create a structure that maximizes market value. 

Value investors are always on the lookout for catalysts. 

• While buying assets at a discount from underlying value is the defining characteristic of value investing, the partial or total realization of underlying value through a catalyst is an important means of generating profits. 
• Furthermore, the presence of a catalyst serves to reduce risk. If the gap between price and underlying value is likely to be closed quickly, the probability of losing money due to market fluctuations or adverse business developments is reduced. 
• In the absence of a catalyst, however, underlying value could erode; conversely, the gap between price and value could widen with the vagaries of the market. 

Owning securities with catalysts for value realization is therefore an important way for investors to reduce the risk within their portfolios, augmenting the margin of safety achieved by investing at a discount from underlying value.  


Catalysts that bring about total value realization are, of course, optimal.  Nevertheless, catalysts for partial value realization serve two important purposes.

• First, they do help to realize underlying value, sometimes by placing it directly into the hands of shareholders such as through a recapitalization or spinoff and other times by reducing the discount between price and underlying value, such as through a share buyback. 
• Second, a company that takes action resulting in the partial realization of underlying value for shareholders serves notice that management is shareholder oriented and may pursue additional value-realization strategies in the future. 
• Over the years, for example, investors in Teledyne have repeatedly benefitted from timely share repurchases and spinoffs.