What is a Catalyst?
A catalyst in equity markets is an event or other news that propels the price of a security dramatically up or down. A catalyst can be almost anything: an earnings report, an analyst revision, a new product announcement, a piece of legislation, a lawsuit, the outbreak of war, an offer to buy a company, a move by an activist investor, a comment from a CEO or government official, or the conspicuous absence of a company officer at a special event.
- Catalysts can be anything that leads to a drastic change in a stock's current price trend.
- The most common catalysts come in the form of new, often unexpected, information that causes the market to reevaluate a company's business prospects.
- Some investors and traders look for catalysts to create short-term market opportunities for profit.
In the financial media, a catalyst is anything that precipitates a drastic change in a stock's current trend. It can be negative news that rattles investors and breaks upward momentum or good news that pushes the stock out of the doldrums. Since a catalyst can take any number of forms, it's better to give a concrete example.
On August 25, 2015, the S&P 500 Index hit a low for the calendar year of 1867.61, 12.51% below its all-time intraday high of 2134.72, which it had hit on May 20 of that year. The decline, which had begun the previous week and hit its stride on August 24, was the steepest since 2011, and dragged a number of quality stocks down out of sheer panic. Nike Inc. (NKE) was one of these: having closed at $114.98 on August 17, it touched $94.50 on August 24.
Yet the business was as solid as ever, and had very nearly recovered by market close on September 24, reaching $114.79. Later that day, the company reported quarterly earnings that exceeded expectations by 12.61%, and the stock shot up to an intraday high of $125.00 the next day. In other words, the catalyst of an earnings surprise propelled Nike's share price upwards by 9.71% in less than 24 hours (and 33.27% in a little over a month), despite lousy prevailing market conditions.
The change was due to new information and a resulting change in investors' perception, not the fact that Nike was 109.71% as valuable on Friday as it had been on Thursday, or 133.27% as valuable as it had been a month ago.
The Importance of Catalysts to Different Investors
Investors will assign different levels of importance to catalysts depending on their market philosophy. Pure value investors ignore catalysts entirely and look instead for operational efficiency, goal-oriented management, reasonable valuation and strong market position. For these investors, catalysts are pleasant surprises – assuming they were correct in their assessment of a company – either providing an opportunity to build up a position cheaply (in the case of falling prices) or realizing the value they'd seen all along (in the case of rising prices).
Pure momentum investors, meanwhile, will watch carefully for catalysts, or their effects on prices, trying to be the first to recognize them for what they are and to buy into a bullish turns or bow out of bearish ones. In reality, few investors are entirely one type or the other, but fall somewhere along the value-momentum spectrum.
An investor might concentrate primarily on a company's fundamentals, but acknowledge that a catalyst will be necessary to realize that value. They might devote significant thought to what that catalyst might be, keeping their ear to the ground when it comes to new products and the state of markets where the company operates. At the same time, the bulk of momentum investors will have some sense of what companies might be undervalued or off the mainstream market's radar. They will compile a watch list and a develop a sense of what news might spark price movements, as opposed to being failed catalysts.