The Dangers Of Story Stock Investing

Investing successfully requires a lot of boring fundamental analysis and often the best stocks to invest in are in boring overlooked, but undervalued companies with strong fundamentals and a decent margin of safety. These companies are not prone to hype.

On the other hand you have story stocks. Investing in a story stock does not mean that your investment will go down in value. On the contrary, a stock with a powerful story could make you very rich. Look at Amazon. Then again look at the multitude of other stocks, which had a powerful story behind them, but that was it. Fundamentally they were houses made of cards, which soon collapsed. The Dot.com crash from twenty years ago is littered with such casualties. More recently, the whole WeWork disaster is a prime example of company with an enticing and exciting story (as well as a charismatic and convincing leader), yet with very shaky and fragile financial fundamentals.

The problem with story stocks is that the stock valuation gets to a point where it is propped up much more by the goodwill of the story alone than by the company’s fundamentals. This is very treacherous territory as even a mild downtown or modest bit of bad news can send the share price crashing back down to Earth.

A stock with a unique story behind it is psychologically very alluring. Doing some solid due diligence such as analysing company reports and financial statements requires effort and if you dont have much experience on that front it can seem very daunting. However, with practice and learning you can become better at analysing and understanding all this nitty-gritty stuff, which also enables you to make better investment decisions with a cool head. Knowing exactly what you are investing in and having even just a modest understanding of the full financial health of a company is a very reassuring thing.

I suppose we prefer stories to analysis, because stories have much more of an instant cognitive resonance. Our minds can be lazy and it’s so much easier and more soothing to be swayed by a good story or glowing article in the media on a stock. More succinctly, sometimes a powerful mantra alone is enough to sway us. Software is eating the world or It’s the wave of the future or You are investing in a slice of history¬†or Nobody else is doing what this company is doing are a handful of mantras that can make us overly bullish on a particular stock without questioning it further or taking it apart via some deep research.

The problem with such stories and mantras is that they activate and play to our emotions and making investment decisions based on emotions is never smart. We always have to have a healthy, balanced, critical and analytical mindset to investing without allowing our emotions to hijack and influence our decision making. A cool head always wins.

 

By Nicholas Peart

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