Investing can feel like a tug of war between cold, hard data and a compelling story. On the one hand, there are number crunchers who specialize in ratios and financial indicators. On the other end, there are storytellers fascinated by the company's mission and its disruptive potential. But the reality is this. Effective investing combines both numbers and stories.
Legendary finance professor Aswath Damodaran, also known as the “Dean of Valuation,” champions an approach that blends storytelling with solid financial analysis. Find out why numbers don't tell the whole story and how thoughtful storytelling can help you make smarter investment decisions.
Why can't numbers tell the whole story?
Many investors rely heavily on financial indicators; stock It is primarily determined by the price-to-earnings ratio or return on investment. But these numbers sometimes miss what actually makes a company extraordinary.
Let's take a look at Amazon in 2014. profit As you can see from the chart below, Amazon looked like a risky bet on paper, given its operating margins, high reinvestment costs, and very aggressive growth strategy. I never thought it was a “textbook'' profitable stock.
Long-term trends in Amazon's operating margin and profits. Source: Macrotrends.
Meanwhile, the Amazon article made a compelling investment case. This was more than just an online retailer. The company was an innovative technology company that rapidly expanded into a variety of specializations, including cloud computing with the promising startup Amazon Web Services (AWS). For investors who viewed Amazon purely as a retailer, this number suggested overvaluation. Those who took a long-term view saw something different. It's a path to reinvestment for growth, sacrificing short-term profitability for a long-term vision of dominating new markets.
In hindsight, that story is more about long-term growth than near-term growth. profit – It turned out to be much more convenient than usual stock measuring gauge. Over the past decade, AWS has become massive. revenue With more than $90 billion in annual revenue as of 2023, the company's dynamics prove that a company's story can tell more than its raw numbers.
Dangers of relying on pure indicators
Conversely, sticking to a “safe” indicator can be counterproductive, especially if the market moves in an unexpected direction. Classic value investing principles – reliable metrics such as low price-to-earnings ratios and high profit margins – were popularized by highly successful investors like Warren Buffett. However, these indicators do not always explain the evolution of the market. This is especially true in technology-heavy industries, where traditional metrics can miss the mark.
Look at Intel. Intel, once a dominant player in the semiconductor industry and a mainstay in value investors' portfolios, has struggled to catch up with emerging chipmakers focused on AI like Nvidia. Indeed, investors who adhere to traditional value principles may cling to Intel in hopes of a return to its former glory. But there's been a clear shift in its story and identity, from a growing behemoth to a usurped company now trying to stay relevant. This doesn't mean Intel is without value, but it does suggest that a new narrative is needed that reflects its future direction.
Revenues from Intel's Client Computing Group, Data Center and AI Division. Source: Finimize.
The Art of Boundary Storytelling
Of course, there's always the risk of embellishing a company's story. When Uber went public, it touted a “total addressable market” of $5.2 trillion, encompassing all of the world's transportation spending, including personal car purchases. Those huge numbers painted a rosy picture, but they didn't reflect the realistic potential of Uber's actual business. Investors who bought into this grandiose story soon realized that the market wasn't that vast.
Bounded storytelling means rooting your story in reality. Damodaran suggests asking three important questions about a company's strategy. “Is it possible?” Is it plausible? Is it possible? For example, can Starbucks maintain growth just by opening new stores? Probably not. With a saturated U.S. market and global competition, Starbucks cannot rely on expansion alone. Compare this to Costco's steady approach to store expansion, which continues to grow and improve even in its 10-year-old stores. Realistic storytelling includes these limitations and helps investors make better-informed choices.
So what is the solution?
Connecting numbers and stories is like combining the logical with the creative. A solid valuation should ground your company's story in reality and provide a roadmap to achievable growth. for example:
revenue Growth: A strong story must realistically support how the company's story drives revenue. Does the company have a growing market or unique product?
Profitability and profit margins: Here the numbers prove the story. Even if the company is committed to growth, will costs be manageable?
Investment efficiency: This assesses whether a company is investing wisely to sustain its story. Efficient reinvestment means less wasted funds. This is an element that Tesla has improved as it has scaled up.
Now, here's how to apply this approach as an investor.
Let's start with the numbers. Understand the basics of finance – it’s revenue growth. profit Margin and return on invested capital. For high-growth companies, especially high-tech companies, lower profit margins can be acceptable if they achieve long-term goals.
Identify the story. What is the company's story? Is it an industry disruptor (like Uber) or a pioneer in a new field (like Beyond Meat)? See if the story matches the numbers. If your company values innovation, make sure your research and development (R&D) expenses align with that vision.
Challenge the story. Play devil's advocate and look for risks and contradictions. For example, while initial stories about Uber depicted it as a “market disruptor” and the new urban transportation option, its growth was never sustainable without significant costs. Challenge overly optimistic growth stories by comparing them to actual financial numbers.
Monitor feedback loops. Pay attention to quarterly reports and macroeconomic trends. Stories evolve and so should our understanding of them. Reevaluating a company's story can help identify changes, like Tesla's transition from a high-risk venture to a market leader. By regularly checking to see if the numbers support the story, you can avoid falling into a narrative that no longer holds true.
Investing is both a science and an art. Numbers provide important insights, but without a compelling story, they can feel empty. Similarly, an attractive story with no economic basis can create a speculative bubble. By integrating numbers and stories, you can get a complete picture of your potential investment.
So the next time you evaluate a stock, ask yourself: What is the story behind the numbers? And do the numbers support the story? Investing with this balanced approach not only increases your chances of achieving long-term returns, but also deepens your understanding of the companies that shape our world.
