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Catalyst

A substance or an event that can cause changes to occur rapidly

What is Catalyst?

The term “catalyst” is used to describe anything that speeds up a rate of reaction or process. In chemistry, it is used to describe a substance that is added to a reaction and increases the rate of reaction.

In finance, a stock catalyst is an event, or expectation of an event, that drastically changes the price of a stock. For example, if a company releases an earnings report that is drastically different than what is expected, then that could be a stock catalyst to change the price of the security drastically.

 

Catalyst

 

Summary

  • The term “catalyst” is used to describe anything that speeds up a rate of reaction or process.
  • In finance, a stock catalyst is an event, or expectation of an event, that drastically changes the price of a stock.
  • In the stock and equity markets, a catalyst can be any new information or occurrence that significantly affects the price of the financial asset.

 

Catalyst in Finance

In the stock and equity markets, a catalyst can be any new information or occurrence that significantly affects the price of the financial asset. Common influencers of the price of a security include new laws and regulatory requirements, market sentiment, financial statements, and earnings reports.

Other examples of catalyst events include the release of a new product or service offering, the creation of a new industry or technology, ongoing litigations, civil unrest or wars, government official comments and statements, the revision of the value of a company or financial asset by an analyst, the notable absence of company management officials or directors at a prominent event for the company, or the receipt of an offer to purchase a company.

 

Example of an Event with Notable Catalysts: The Dotcom Bubble

The dotcom bubble began in the late 1990s, reaching its peak in 2000 and finally bursting in 2002. During the 1990s, the information technology sector became more attractive, and new IT companies began to surface. The new-found popularity of the IT sector led to the creation of several internet-based businesses, including dotcoms.

Due to the traction in the IT sector, funding for ventures within the space became easily available, with investors and venture capitalists seeking to make sound investments with the potential for sound revenue generation and overall growth.

Following the popularity gained by the IT sector, a few web-based companies (Netscape, Yahoo!, Lycos, and Excite) were able to hold successful IPOs. Due to the nature of the businesses and their domains (“.com”), market participants began to believe that dotcom companies made for sound investments. People began to purchase shares in an internet-based business with a “.com” domain, with a number of these individuals selling off their shares in other companies to purchase dotcom shares.

The upbeat market sentiment led to a significant increase in the stock prices of the dotcom companies that were operational at the time. The dotcom bubble saw an end in 2002, with stocks on NASDAQ seeing their market capitalization decline by a massive $5 trillion. It was attributed to some companies not meeting their benchmarks and milestones or not generating revenue.

Hence, the notable catalysts here were the market sentiment that led to the inflation of the stock prices, financial statements, and earnings reports, which highlighted poor performance for some of the dotcom companies, the initial release of a new product or service offering through web-based platforms, the creation of a new industry (e-commerce), and the revision of the value of a company or financial asset by investors and analysts based on the performance of the companies.

 

How Investors Make Use of Catalysts

Investors tend to adopt varied philosophies when it comes to their respective target investment markets; therefore, the level of importance they allocate to different catalysts may diverge from one investor to another. Different investor types typically fall into the value investor classification or the momentum investor classification, and some can be in between.

Momentum investors tend to focus on catalytic events and the price fluctuations that result from such events. The investors identify the nature of a catalyst and the possible outcome (bullish or bearish), and it informs them of whether to buy or sell an asset.

When looking at value investors, they are not interested in catalysts. Such investors are focused on sound valuations, durable market share and positioning, operational efficiencies, and a strong management team that is committed to meeting performance targets. If these investors initially carried out sound analysis and assessment of a venture or business, they see catalysts as a form of constructive surprise, as the catalysts support their analysis or their valuation of the business.

Additional Resources

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