It is known that stock price is the discounted value of earnings, more importantly cash flows. While earnings or cash flows stem from the reality, i.e. the financials of the company, often, it’s the story behind the numbers which determines the stock price.
When Story is more dominating than the financials, you run the risk of having minimal margin of safety, in simple terms, over-paying or losing your investment entirely. The risk gets undertaken because:
- You believe that the now, weaker financials as compared to the story will eventually catch-up!!
Start-up world is a classic example, wherein many VCs resort to “spray and pray model”, i.e. pour in money on multiple start-ups primarily based on their story(ies), while only a miniscule of their investments end up becoming winners.
- You believe that your chosen company’s management with their blinding persona will wave a magic wand in a difficult industry whose business economics have been historically dismal – most industry players facing extreme competition, no pricing power, capital intensive, sub-par return on capital/equity, increasing leverage, equity dilution.
Think of Naresh Goyal and Vijaya Mallya in the airline industry, Wadhawans of HDIL in the real estate industry, etc.
All this story(ies) works out great till it holds up – it is like Cinderella’s ball before it strikes 12 o’ clock – everything is hunky dory!! You only realize who has been swimming naked when the tide runs out, i.e. when the story does not play out as per the reality.
Focus on Reality my friend, most stories eventually fade away!!
Disclaimer: Please note that these are my personal views. While I am NOT a registered Research Analyst as per SEBI (Research Analyst) Regulations, 2014, all investors are advised to conduct their own independent research into individual stocks or industries before making any decision. In addition, investors are advised that past stock performance is not indicative of future price action.
When we started investing we are enamoured by stories. It took 15 years to realize that most stories although exciting never become reality. thanks for writing this post