Do numbers increase conviction in investing?

Whenever we speak to our clients, they have a very different perception about investing. They think that investing is all about number crunching and forecasting the future. While this does form part of investment analysis, but it is not as crucial as the narrative.

“Never invest in any idea you can't illustrate with a crayon.” – Peter Lynch

We often communicate our investment ideas with our clients in stories and less numbers. While there is lot of number crunching which goes into investment analysis, but as an advisor our job is to illustrate the same in simple language; so that an investor understands what exactly she owns and why.

Quite a few studies suggest that just facts or numbers don’t stick well with humans but same is not true with stories. Aswath Damodaran, valuation professor himself writes in his book “Narrative and Numbers, The Value of stories in Business”,

“… studies indicate the staying power of stories. Stories get remembered much better and for longer periods than numbers. In one study, subjects were read stories and expository texts and their memory was tested later. Even though the content was the same, the stories were remembered about 50 percent more than the expository passages. As to why some stories get remembered more than others, researchers hypothesize that it is causal connections within the story that make them more memorable, especially if subjects have to work to make inferences and see the connections.”

As an investor/businessman, one often finds himself in a situation of uncertainty about the future. How much ever data an analyst/consultant presents to an investor/businessman, it fails to give them conviction about the future. But what really sticks? It is a story that works.

Whenever you come across a situation of uncertainty in investing, your portfolio may be down from their highs but always remember the underlying stories of your stocks. It could be;

i) Brands of a company – Fevicol, Jockey

ii) a company’s edge in distribution, sales, marketing – Maruti, Asian Paints

iii) the management ability to be cost conscious and operationally efficient – Relaxo, Supreme Industries

iv) Under penetration in the economy –Banking, Pharma

It is exactly such things that will give you confidence to hold on to your stocks.

Numbers are useful to ascertain that the narrative is plausible & sustainable. Beyond that it doesn’t serve any purpose. Every business undergoes cycles and every downcycle would send shivers to investor/businessman. But if an investor truly believes in a story, she would stay undeterred in rough conditions.

Unfortunately, stories travel much farther than what we would like them to. This could one fall out of story telling. In good times like bull markets, stories influence investors so much that she ignores numbers completely and bets her house on it. Some brokers and fraudsters take advantage of this investor fallacy to sell their trick in the market. This can be seen by the fact that why 90% of the IPOs went below their IPO offering price over time. Also overall market returns from one bull market to another have remained quite subdued and haven’t beaten even Fixed Income returns.

We believe stories must be used to our advantage and must be in conjunction with numbers. Often numbers give false precision but if narrative is good, it tends to stick along longer and stronger. We use number as foundation but our stories take us far. In most of our investments basic underlying stories gave us more courage to buy and hold, rather than plain numbers.