Investment Catalyst: Must-Have or Nice to Have?

Hailed by The New York Times as a "guru to Wall Street's gurus," value investing expert Bruce Greenwald takes some time to offer his insight and advice to The Motley Fool. A professor at Columbia University's Graduate School of Business, Greenwald has also authored multiple books, including Value Investing: from Graham to Buffett and Beyond.

Value investors are often cautioned that they must have catalyst before investing in a stock. Greenwald discusses the margin of safety and how to determine whether a catalyst is in fact necessary.

Full transcript below.

Matt Koppenheffer: With the derivatives, one of the things that we heard a lot at the Value Investing Congress is about the catalysts for an investment. You buy a stock, you think it's cheap, and you look for the catalyst that's going to get it there. Do you think it's necessary for an investor to have a catalyst, or have a catalyst in mind?

Bruce Greenwald: OK, that's a really good question, because again, it comes back to valuation.

If your valuation is transaction-based, for example, so you're looking at recent transactions -- by even informed buyers -- for cash, the problem with that is it's always driven by market valuations to some extent. If you're doing that, there is a lot of implied risk in that valuation, and you really want a catalyst.

That's the basic insight that Mario Gabelli had, because he believed in private market value, and he also understood that private market values were not that stable, so he wanted catalysts that would realize them as soon as possible, and if nobody else had them, he was going to try and create them either by touting the stock to somebody who would buy it out, or going to the management and asking them to do something.

I think that, in general, if you don't have a lot of confidence in the valuation, then you've got to have a catalyst.

On the other hand, if you have a good margin of safety in even a non-franchise stock, where you're not growing -- so the stock, you're pretty sure there are real assets there, it's going to be worth $100 a share, and you're buying it for $50 -- if you keep that investment for three years, and it takes three years to realize that value, well a double in three years is a 24% return a year.

Koppenheffer: Not bad.

Greenwald: If it's four years, it's an 18% return a year. If it's five years there's a 14% return, plus whatever dividends you're getting in the meantime.

I think that, if you've got a reliable valuation, you ought to have a lot of staying power and still get a decent return. I think one of the advantages of a big margin of safety is it gives you three to five years for the market to come around.

If you have patient investors, they're not going to give you a hard time in the meantime. I think, again, back to the question of insurance, that's the nice thing about having an insurance float.

I think the issue of catalyst ultimately comes down to an issue of confidence in your valuation. If it's a franchise business, and you're getting a decent return; if we're getting our 10% a year for Nestle, and we also think that it's 25% undervalued -- how we'd arrive at that calculation, who knows -- but we're also waiting for a 25% bump, don't forget we're getting 10% a year while we wait, as value accrues.

There, we can wait five to seven years and we're fine. Again, it depends on the nature of the company, the nature of the valuation that you're doing, and the reliability of that valuation. You don't want to just say, "Oh, I'm only going to do things with a catalyst."

Buy and hold stocks
With the American markets reaching new highs, investors and pundits alike are skeptical about future growth. They shouldn't be. Many global regions are still stuck in neutral, and their resurgence could result in windfall profits for select companies. A recent Motley Fool report, "3 Strong Buys for a Global Economic Recovery," outlines three companies that could take off when the global economy gains steam. Click here to read the full report!


Read/Post Comments (1) | Recommend This Article (2)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2679578, ~/Articles/ArticleHandler.aspx, 12/20/2014 3:59:59 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement