The Problem With Investing in 'Stories'
We all love a good story, and Wall Street tells stories better than anyone.
Tesla is the future of transportation!
Amazon is redefining the world of retail! Who cares that it isn’t profitable!
The bond market will do great, no matter what happens with interest rates!
Over and over again, it’s the same old thing.
From an investor’s point of view, the problem is that falling in love with a story can often lead to disastrous results if real-life events don’t work out as well as the story suggested.
The 2000 movie “Boiler Room” — starring Vin Diesel as a stockbroker! — gives a pretty good look at how dangerous a great story with no actual substance can be to your net worth.
From the promotional poster:
“Welcome to the infamous ‘boiler room’ — where twenty something millionaires are made overnight. Here, in the inner sanctum of a fly-by-night brokerage firm, hyper-aggressive young stock jocks peddle to unsuspecting buyers over the phone — and are rewarded with mansions, Ferraris and more luxury toys than they know what to do with. In this unassuming Long Island enclave, Gen Xers chase the green at breakneck speeds, sometimes one step ahead of the law.”
“Gen Xers.” Heh.
But the point is, penny stock brokers with great stories have cost investors millions of dollars over the years.
Not just for suckers
Think “real” Wall Street is immune from this? Think again.
I remember my early days as a stockbroker at Dean Witter. Every morning, the research department would send us a “stock of the day.” It would have a great story outline that we would pitch to clients and prospects.
This was back in the days when cold calling was still a common practice in the industry, and we were told to make 300 or more dials a day to build our client book.
Yes, the glamorous world of high finance.
My first week on the job, I used one of those stock of the day ideas to reel in a few new clients. The stock was a chain of day care centers, and the story was all about women returning to the workforce and the fast-growing need for quality day care. This was back in the 1980s, so it this was a new thing.
It worked like gangbusters.
The problem was that the numbers behind the company weren’t as good as the story said they were.
The stock traded at a premium PE multiple and had some liability issues at a few of their daycare centers. Soon after, the company announced disappointing earnings and it went south quicker than snowbirds in November.
All of those new clients quickly became former clients.
There is a bright side
Lesson: When it comes to investing, numbers are far more important than stories.
Full disclosure, we own some fantastic stories in the Choose Yourself portfolios. We’re investing in driverless cars, potential cancer cures, biometrics, cybersecurity, renewable energy and more. All great stories!
But there is a difference. When we invest in companies we do it, not because of the story, but because the company’s underlying number make sense.
The companies in our portfolio are all financially solid with little risk of financial distress, and the fundamentals of the business are positive and improving. We paid what we consider to be a bargain price based on their strength and outstanding prospects for all of them.
We bought the numbers, and the great stories are just a bonus.
Written By Tim Melvin
As a 30-year veteran of the financial services and investment industry Tim Melvin served as a broker, advisor, and portfolio manager. He’s combined this nearly three decades of experience with a love of value investing in order to help investors worldwide to multiply profits and build their nest eggs. As an avid value investor, Tim...