This article is authored by MOI Global instructor Michael Melby, founder and portfolio manager of Gate City Capital Management, based in Chicago.
“I don’t believe in psychology. I believe in good moves.” –Bobby Fischer
When explaining our thesis for one of our portfolio companies, we are often asked by other investors to identify the potential “catalyst” for the company. In this context, a catalyst is an event that causes the company’s stock price to move higher and reduce or eliminate the market’s discount to our calculation of intrinsic value.
While we understand the nature of the question, we find little value in attempting to identify potential catalysts.
We value companies based on the amount of cash we expect the company
to generate for the company’s owners and not on what we hope others might pay us for the company at some point in the future. In our view, this philosophy is consistent with that of a long-term investor looking to be a business owner versus a speculator dependent on the behavior of another market participant. As business owners, we strongly prefer our management teams to be focused on operating the business to maximize future cash flows rather than managing the business in pursuit of catalysts.
Behavioral finance studies how psychological and emotional factors influence human behavior and ultimately impact market prices and asset returns. The topic is a popular one for investors, with experts on the subject writing best-selling books and winning Nobel Prizes.
Humans are said to have certain inherent biases that prevent us from making the best decisions. Armed with an understanding of these biases, an individual can either encourage others to make better decisions to benefit all of society or encourage others to make bad decisions and capitalize on their mistakes.
We think that all humans attempt to maximize their own personal utility, and the incentive to improve one’s own personal fortune has led to technological progress and higher standards of living for all.
However, this desire for advancement does not guarantee the best decisions are always made. To err is human. It would be illogical to think that humans should make the optimal decision in every situation, especially when considering the thousands of choices each of us make every day.
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