Value Library

The following is an excerpt from the ABC Perspective - October 2000 - Pg. 1

Catalyst

Underperforming value stocks often need a catalyst to stimulate price appreciation. Quite often a poorly followed value stock will drift downward in price and remain cheap for a considerable period of time until a catalyst unlocks its value.

While waiting, investors often lose patience. They sell the stock and the share price declines further. The lower the stock falls, the more investors avoid the stock. Even once-curious potential investors assume something is seriously wrong with the company and may back off.

But eventually a catalyst does emerge. It could be anything such as a new contract, the sale of a division, the purchase of another company, the invention of an advanced process or even a TSE 300 listing. The catalyst suddenly generates investor interest and with it a whole new investor following is created. The shares, having been discovered, surge in price. A recent example that comes to mind was our ABC Funds’ holding of the common shares of Industrial-Alliance Life Insurance.

In February, we purchased Industrial- Alliance, a fundamentally undervalued, small capitalization, demutualized life company. At about $16, the company was deeply underpriced and along with its larger demutualized peers, it did quite well. As Industrial-Alliance appreciated, we reviewed the company and raised our target price three times. We continued to favour the company but when it broke through $30, we believed that Industrial-Alliance was no longer undervalued. Unfortunately, liquidity was very limited and the sale of a large block of stock could have severely depressed the share price.

But a catalyst suddenly materialized. There had been increasing speculation that Industrial- Alliance was to be included in the TSE 300 Index and, in fact, on Tuesday September 19, this was officially confirmed. The stock rose substantially and we were able to liquidate our entire holding of 600,000 shares at over $33. While this is not to imply that Industrial-Alliance may not appreciate further, we felt that we had made a full and substantial gain on a relatively illiquid stock. Ultimately, we benefited from the sudden appearance of a catalyst that created an opportunity to sell our entire holding.

This example has led us to the following conclusions:

1. The market eventually discovers good value in overlooked companies.

2. While underpriced value stocks often appear to have no sizzle, a timely catalyst can suddenly turn a dull, illiquid shareholding into an exciting, newsy momentum stock.

Irwin A. Michael, CFA