Litigation/Regulation is the final catalyst on my list (here’s the first post in the series). It’s also, without a doubt, the most difficult to exploit & to write about (note I’ve tackled this series in reverse order)! In fact, if it doesn’t (immediately) appeal to you, I might perhaps discourage you from ever bothering with this catalyst? To some extent it suffers from the same issues/perceptions I highlighted with v) the Major Sale catalyst.
First, most litigation/regulation risk/events are simply part & parcel of normal corporate operating activity. For example, certain sectors are almost permanently marked down due to their increased risk level (perhaps something politicians like to mouth off about?!). These risks usually aren’t of any fresh/major significance to a company’s business model or valuation, and/or they’re routinely priced in anyway – they are not catalysts.
But occasionally a real game changer comes along… A lawsuit, or a regulatory change/threat/action/approval, that could prompt a major change in a company’s future intrinsic value. It may also cause a rapid/significant adjustment in the company’s current market cap. So how exactly do we separate out & identify such a catalyst vs. the merely hum-drum? Something like:
A litigation/regulation risk or event that may cause at least a 30-50% change in the intrinsic value and/or market cap. of a company may offer a significant catalyst.
Of course, this kind of existential threat (or possible opportunity) is difficult to handicap. I mean, the company may not even have a handle on it! Even if they do, they may prefer to wallow in denial, or simply remain unwilling to share the nitty-gritty risks/detail with shareholders, let alone the external world. And if you’re an investor who likes to research & take on this type of risk, in reality the outcome’s still always going to be binary – which can lead to v different financial results.
The correct approach with binary (or multiple) outcomes is, of course, to use an expected value approach: Identify each outcome, try to handicap its probability, evaluate the potential financial impact, and repeat... Once you’ve covered the spectrum of probability/outcomes, you can calculate the resulting expected value of the financial impact & consider it in relation to the current market cap.
If you’re a smart & consistent handicapper, you can reasonably expect to make good money over time. Trouble is, in…
