Of all the behavioral traps that investors succumb to, few stand out as much as the innate tendency to fall prey to stories. The allurement of stories, it would appear, is hardcoded into our DNA.
Nasim Taleb, in his pathbreaking book "The Black Swan", explores this fallacy succinctly, noting that stories serve to "severely distort our mental perception of the world". Disturbingly, experiments have proven that good storytelling can swing juries in a different direction, and even influence key decisions in the field of medicine. Zaffron and Logan, in their modern leadership classic "The Three Laws of Performance", even illustrate how leaders use the art of storytelling to shepherd their flock towards an "invented future", influencing complex, collective organizational outcomes in the process. Good stories, it seems, can move thousands of people in one direction; and good leaders must also be good pied-pipers!
In the investing world, stories can prove especially dangerous, and can even serve to kick start a multitude of other firmly embedded behavioral biases. Stories regularly influence investment decisions; and usually not in a good way. Retail investors, armed with a little bit of information, get swayed often by the siren song of market tales. Business news channels serve to exacerbate the problem - after all, good stories sell!
Year in and year out, stock market stories seem to have a few recurring themes. At the forefront, of course, are the stories of companies that have already done well, posted great results, or have become multi-baggers. What about the so-called value stocks that haven't done well, but are potential turnaround cases? They rarely make the news in time. Resultantly, retail clients tend to flock in hordes to stocks that have already gone up in value; almost invariable culminating in the booking of portfolio losses. After all, consistent stock market profits can only be made by being ahead of the curve - and investing into companies whose future potential the broad markets have not fully recognized yet.
IPO's are another prime example of the power of storytelling. Nearly 2/3rd of the 178 IPO's that hit the Indian market between 2008 and 2015 were trading below their issue price as of January, 2015. In the U.S too, a study discovered that the average IPO underperformed the broader market by as much as 21 per cent in the 3 years after its listing - across all IPO's launched between 1980 and 2007. IPO's usually make terrible investments; and yet - investors queue up for a piece of the pie repeatedly. The better the story, the higher the oversubscription. Stories trump evidence and facts each time.
Private equity placements make fantastic stories too. When New Silk Route (9.48%), Baring Private Equity (5%), Siva Trade Consultancy (4.8%) and other private funds bought shares of K.S Oils May 2009 at 50 apiece, the media and investors lapped up the story. Nomura threw in a 'Buy' recommendation. Retail clients rushed in. The stock is wallowing at 50 paisa today, and this isn't an isolated example.
The stories just keep pouring in all day, causing our neurons to fire in all directions. The GST story, the demonetization story, the budget story, the Trump story, the India infrastructure story, the PE re-rating story, the rate cut story… Wherever you look, there's one. And it's influencing your investment behaviors on a real-time basis. How, in such a situation, can you invest wisely in stocks or sectors that are poised to unlock value over the long term, Buffett-style?
The answer is: by slipping on a pair of earplugs, focusing on facts (such as earnings, earning growth, assets, dividend history, competitive advantage) and disconnecting from the allurement of market stories. Eventually, there's only one reasonable indicator of how a stock will perform - and that is, how much earnings growth the company is most likely going to achieve from this point on, and just how much of that growth is already priced into the stock, given a reasonable multiple. Ditch the stories and adopt the philosophy of buying "Growth at Reasonable Prices" (GARP) and holding on instead. It worked for Mr Buffett, and it'll work for you too!
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