In this post, we’ll explore the concept of Narrative and how it explains the gap between old-school fundamental investment value and what we observe in the public marketplace.
Years ago, individuals looking for financial information had The Wall Street Journal and a few other publications. There was no financial TV. Now we swim in an ocean of information. We tend to consume economic and investment information without realizing it.
If we’re not careful, we absorb information from sources that simply reinforce our beliefs rather than challenge them. Behavioral economists call this “confirmation bias.” Here at Adams Capital, we visit with many extremely educated and market knowledgeable people who remain mystified at these new market highs. We all agree there is a new component of “value” that is challenging to predict or measure. We can call it Narrative.(1)
If we were to hold to the classic valuation standards and compare those to the current public market valuations (August 2021 all-time highs), we would all be market bears. Yet faced with undeniable error, we adapt. Consider the idea of Narrative as a market driver.
In this post, we’ll explore the concept of Narrative and how it explains the gap between old-school fundamental investment value and what we observe in the public marketplace.
Tesla and Narrative
Tesla is a popular company, with a current stock price of over $1,000 and a market cap of just over $1 trillion at the time of this writing. For comparison, Toyota’s stock price is at about $177, for a market cap of just under $300 billion.(2) So Toyota trades at less than ⅓ of Tesla. In 2020 Tesla sold around 500,000 cars, while Toyota sold 9.5 million cars — 19 times as many as Tesla.
Depending on who you ask, there may be no justification at all for the value of Tesla being more than triple Toyota’s value or completely justifiable based on expectations. The value of a business is dependent on expectations of future earnings. Some analysts perform base-level estimates and others have forecasts that assume Tesla will be able to profitably build and sell the new android robot. Many people thought Amazon wouldn’t be able to deliver on their expectations, but they have, and they continue to break into new areas. Can Tesla do this? The market has already given us the answer: Yes, it believes Tesla can. At least that’s the “Narrative” for now.
How the Idea of Narrative Impacts Stock Price
How does Narrative impact Tesla’s stock price? Part of it is the popularity of the Narrative. Like AMC and Gamestop, Tesla has a devoted group of fans who want to support the company. If enough people like and buy stock in a company, the stock price increases. Tesla has become synonymous with multiple trending movements such as green initiatives, electric cars, and artificial intelligence. Tesla is a top holding in multiple ETFs related to autonomous technology, innovation, robotics, and clean energy. While on paper they may be a car company, in the minds of investors Tesla has come to represent much more.
All companies have Narrative. Toyota builds reliable cars, but the market doesn’t expect them to start a new industry building humanoid robots. The value of the company, or stock price, reflects this Narrative. To justify respective stock prices, a financial model for Toyota will likely have a modest profit but slow growth, whereas a financial model for Tesla will generally involve aggressive growth projections despite current losses.
Narrative Impact on the Stock Market
There's not a limit to Narrative! We can't rely on historical limits to speculation. There is something in people's heads that is different. Narrative is not based on fundamentals. Narrative is not even constrained by historically reliable limits.
This does not mean that valuations will forever go up. It means we have to constrain bearishness to periods where market internals are negative — in other words, when mentality shifts toward risk aversion. It has a lot to do with Narrative.
There is a story of two young fish swimming. An older fish that comes by and says, "How's the water, boys?" and swims away. After a while, the young fish look at each other, and one of them says, "What the hell is water?" Water is the Narrative. It's swimming without even knowing that we're swimming in it.
The water in which we swim is the water of Narrative. Narrative is the articles that we read, the conferences we attend, and the speakers we listen to. It's what we hear on CNBC, what a politician says to us, and what Uncle Warren tells us at the Omaha conference.
We know, in our hearts, that we are impacted by Narrative. We are human beings, and we evolved over millions of years to respond to these messages. That is what it means to be a social animal. That self-fulfilling process creates the water that we swim in, Narrative, the massive amount of information that inundates us daily.
Markets are basically places where people have beliefs, they turn them into behaviors, they produce market behavior, and then that market behavior comes back around and informs their beliefs. Mental beliefs become individual behaviors, which become market activity, which then affects beliefs. Knowing where you are in that cycle is critical to investing success.
How Narrative Impacts Private Companies
It is important for any financial model to accurately depict “Narrative” factors influencing the value of a company. By virtue of being a publicly traded company, one immediately gains a number of analysts who build financial models based on Narrative cues from earnings calls, headlines, and personal opinions. Most privately held businesses don’t have analysts to translate long-term expectations to a supportable stock price. For a private business to access and leverage Narrative, the private business will need to become a public company that captures this special Narrative public attention.
Using Narrative to Your Advantage
Adams Capital has experience in helping businesses navigate market changes and the changing impact of various factors on business value. We offer a no-cost initial telephone consultation to business owners.
Please email us at tara@adamscapital.com or call us directly at 770-432-0308 to schedule a consultation or to learn more.
1. Loosely based on thoughts from “permabear” John Hussman and expert in game theory and econometrics Ben Hunt.
2. November 10, 2021
Author
David Adams is the President of Adams Capital, LLC. He is an expert in the valuation of businesses, business interests, and tangible and intangible property for mergers and acquisitions, corporate recapitalization, privatization, gift and estate tax planning, bankruptcy proceedings, dissenting shareholders, Employee Stock Ownership Plans, and financial and tax reporting. Frequently counseling business owners and families on methodologies to enhance shareholder value.