The difference between professional investors that outperform the market and those that do not often comes down to the basic approach. Institutional and professional investors actively search for inflection points and the catalysts that will drive a stock higher. All too often, everyday investors buy stock following positive news or based on past performance. The problem is past performance is not necessarily an indication of future performance. While it will help establish a track record for a company or management team, it does not indicate why the stock should continue to increase in value and outperform the market. The news is priced into the stock’s value.
As part of an investment thesis, investors need to identify what the Street expects and where the company can outperform or underperform there expectations. These are the positive/negative catalysts that will increase/decrease earnings forecasts or result changes to how the stock is valued.
Stocks beat the market rate of return when they beat expectations. The expectations are often tied to specific events called catalysts. These come in a variety of forms from earnings releases to the successful integration of a large acquisition. Here are a few ideas of where to look for stock catalysts:
- Earnings will beat consensus estimates: Earnings beats will often lead to increases to earnings forecasts and the stock price as a result. This is probably the most often cited, but it is incomplete. Investors need to explore why and where the earnings beat will come from. Some sources include:
- Market Share Gains: Behind a better product, promotional activity, new product introduction or other strategic initiatives, a company gains market share and growing sales faster than the industry and the market expects.
- Price increases: The company raises prices by a greater amount than costs increased
- Cost reductions that improve margins: Strategic initiatives to cut costs lead to margin beats. Often these initiatives are well know so a beat from here is usually behind better than expected execution by management.
- Sales outperformance: Sales can beat for multiple reasons, one is listed above in market share gains but there are others such as industrywide growth.
- Acquisitions/Divestitures: These are hard to predict but can improve the earnings power of a company if it’s an acquisition. A divesture can provide cash or just an exit from a non-core business.
- External, Industrywide Indicators: Industry data points are often published and can act as a key catalyst. In trucks for example, the ACT releases monthly North American sales data. A better than expected number is a positive catalyst for truck and component manufactures. In addition, macro data such as GDP and unemployment data can contribute to stock performance.
While some catalysts are hard to track others are not. For example, industry sales activity, company price increases and market share shifts are all indefinable from performing research on an industry or company. A firm such as Research Optimus can provide the skill set to dive into these critical issues for investors and provide the edge needed to outperform the market.
As you develop your investment thesis and identify potential positive and negative catalyst, identify how to track them. It is necessary to follow industry news, earnings releases and perform proprietary research in order to beat the Street.