IT’S DECEMBER, DO YOU KNOW WHERE YOUR CATALYST IS?
There isn't much market analysis that has changed since my weekly review posted on Sunday. We are in a bull market. I am bullish. And I am looking forward to moving up to 100% long from the current 75% long exposure. Simple stuff.
I want to discuss the importance of catalysts in an investment. Far too many investors get caught in a trap of looking at an investment from a purely theoretical value basis without searching for what factors can potentially bring out that value. You see, we are not in an environment where equities are in high demand. That simple fact can cause companies that are lacking a tangible catalyst to languish for far longer than investors can stand to wait.
The stock being cheap according to every metric in the book doesn't matter. The product being revolutionary makes no different whatsoever. The management being brilliant doesn't make an ounce of difference. None of these qualities matter when equities are held in the same light as a one legged Cambodian hooker.
In June of 2011, I wrote an article for TheStreet discussing the importance of catalysts in an investment, along with 3 companies that had clearly defined catalysts going forward. The companies mentioned were CPSS, MAMS and ANFC. Some 18 month after the article was written, CPSS has gained 443%; MAMS has gained 76%; and ANFC has lost more than 50%.
I shouldn't have missed CPSS and MAMS this year. They were both on the radar. They were both clear opportunities. I simply got caught up in other names that I thought offered more substantial opportunities. Disappointing error in judgement on my part.
Now that we know how on point the analysis for CPSS and MAMS turned out to be, as well as knowing how the analysis for ANFC fell into quicksand, we can gauge the importance and timeliness or lack thereof in each investment.
With respect to CPSS, the key read was twofold:
1. They were gaining consistent access to credit facilities that allowed them to lend more to their subprime consumer base, increasing earnings. EARNINGS CATALYST
2. A former board member, Arthur Levine, purchased $1 million worth of the stock in 2010. Mr. Levine had been an active investor in the company at previous points where the company required capital. ACTIVIST/INVESTOR CATALYST
Although CPSS was trading at ridiculously low valuations, a valuation measurement is never a catalyst by itself. There needs to be an event or series of events, whether earnings related, macro related or activist related that create a spark for the company.
The MAMS investment had two distinct issues that made it attractive:
1. It was a spin-off that was completely and utterly forgotten. The timing of the spinoff was at the onset of the financial crisis in 2008. Investors didn't want to touch blue chip companies let alone a small-cap spinoff in the software industry. This is not an actual catalyst but rather an event where poor timing by the parent company makes the spinoff more or less invisible to investors regardless of the story.
2. The company completely restructured in 2010 from the ground floor. Additionally, the restructuring came during a period where the economic landscape favored their particular industry.
In the case of MAMS, you had a company that was not just under the radar but underneath a layer of Earth. In the meantime, the company was gaining efficiency through restructuring initiatives covering management, debt and strategic vision. All the meanwhile, it was in an increasingly favorable sector of software services. Several catalysts were at work here in addition to valuation.
ANFC was a bit more difficult of a proposition due to one fact...and one fact alone: The catalyst involved was macro in nature. Macro catalysts, in ANFC's case energy, are notoriously difficult to gauge. It is the reason you don't see me mentioning or researching energy, metals or material stocks. There are easier fish to fry.
In the case of ANFC, there was a land value factor. It was part of the Bakken craze. And, of course, oil prices were the key to all of this. Like most Bakken related stocks, ANFC has hit a rough patch over the past 12 months.
This is a very abbreviated view of what a catalyst should look like. In any case, I don't make an investment without one and neither should you. A spark should always be there to allow that attractive valuation to bloom.
That is all....
