1 Factor that Can Let You Earn Higher Returns While Taking Lower Risk

Some say that to gain more profits in the share market, you have to be willing to take more risk. Investing maestro Warren Buffett won’t agree with that statement. He believes that the degree of difficulty you attempt doesn’t count when it comes to business and investing. In other words, taking on more investment risk does not necessarily bring you more profits.

But how is it that you can increase your investing gains while lowering risk?

Defining an investing catalyst

Author and investment analyst Dennis Jean-Jacques believes that finding a catalyst for your investment could be a factor that can increase your investment returns while lowering risk. He elaborated on this factor in his book 5 Keys to Value Investing:

“While buying assets at a discount from the underlying value is the defining characteristic of value investing, the partial or total realization of underlying value through a catalyst is an important means of generating profits. Furthermore, the presence of a catalyst serves to reduce risk.”

Said another way, Jean-Jacques encourages us to look beyond the basic investing tenet of buying shares at a discount, and to look hard for a visible catalyst or event which can allow the underlying value to be recognized.

In this sense, it is not robust enough for the Foolish investor to simply take the historical growth rates of a particular company and simply extrapolate the growth rates into the future. If that company is not able to find new – and historically comparable – areas of growth, those growth projections may just collapse like a house of cards in the future.

Finding a catalyst

The more astute Foolish investor should identify why growth will continue into the future, or how a potential event (catalyst) may lead to value being created and recognized.

Take bank software systems provider Silverlake Axis Ltd (SGX: 5CP) as an example. Analysts are expecting the software outfit to benefit from Oversea-Chinese Banking Corp. Limited’s (SGX: O39) recent acquisition of Hong Kong-based Wing Hang Bank. The catalyst in this case could be the expansion of existing software contracts with OCBC into its new entity, Wing Hang Bank.

The questions that investors might ask are: What level of new revenue can Silverlake Axis expect from this merger? How robust are the estimates and assumptions? At Silverlake Axis’ current price-to-earnings ratio of about 29, does the share price fully include the potential for growth? Is the potential pay-off from shares of Silverlake Axis enough to beat the long term returns of the SPDR STI ETF (SGX: ES3) of about 8.5%? The SPDR STI ETF is a proxy for Singapore’s market indicator the Straits Times Index (SGX: ^STI).

Foolish summary

As lifelong students of investing, we should always seek to refine our investing process over time. Finding a catalyst for your investments can add another arrow into your investing quiver. The more lenses you have from which to view your investments, the more refined your investment thesis can be. Read more about investing and get more investing tips and tricks, FREESign up here to The Motley Fool Singapore’s weekly investing newsletter, Take Stock Singapore.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.