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Analysing companies: stories or numbers?

Data is data and stories are stories. Which is more important for investors to understand?


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I'm sure that over the last few months, everyone reading this article would have closely followed all the news about the elections as well as the various opinion polls and exit polls. However, investors would probably not realise that there was an important lesson for them in the media coverage of the elections.

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Now that the dust has settled, the one fact that stands out is that exit polls had a much higher accuracy than conventional journalistic coverage of the elections. News articles, opinion pieces and TV news coverage was all over the place and, compared to the exit polling that was taking place at the same time, was substantially inaccurate about what the voters were thinking and doing. As the election results came out, this discrepancy was mostly just ignored, or explained away with the expected accusations of bias and/or incompetence.

However, investors, especially equity investors should pay heed. I don't see this as a 'journalism vs exit polls' issue, not at all. The reason is that in a very real sense, exit polls are also journalism. Exit polls are essentially an activity that involves gathering the opinion of a lot of people, analysing it, coming to conclusions, and then publishing them through the mass media. That adds up to an activity that fits well within the ambit of journalism. The difference lies in the scale and the methodical approach. In legacy journalism, someone goes out and talks to 10 or 20 people, takes some notes, gathers some impressions and comes to a conclusion. In an exit poll, structured questions are asked of lakhs of people, the responses analysed and conclusions reached.

It's the same kind of activity. The difference lies in whether we are dealing with stories, or with data, and the way I've put it, I'm sure you think that I'm saying that data is superior to stories. Not quite.

Some time ago, I read a most interesting book that entirely consisted of this discussion. This was 'Narrative and Numbers - The Value of Stories in Business', by Aswath Damodaran who is a well-known professor at the Stern School of Business, New York University. Damodaran teaches equity valuation and has a tremendous reputation in the field. Conventionally, equity valuation has been seen as a purely (or mostly) numbers driven activity. In 'Narrative and Numbers', Damodaran argues that the numbers-only approach is quite inadequate. Valuing investments by numbers alone, without understanding the story, leads investors to a position where they don't really understand anything meaningful. Or rather, they may understand the what, but will have no perception of the why and the where.

Conversely, there are many businesses, including most of the 'startup' type, where the narrative is great, but the numbers don't match up to the narrative. In fact, the narrative is all there is and a reliance on the narrative alone leads to misunderstanding and mistakes in valuing the business. Damodaran talks about companies like Theranos, where there's just the story and Tesla, where there is some basis to the story. From the past, there is Apple's second coming, which was a story and then the numbers too took shape.

When one looks at just the story, then one does not know whether it is connected to the underlying reality, as you can see in the elections example I gave. When there are just numbers, you don't get the relevance of those numbers, or why something is happening or not happening. Hypothetically, consider a situation where the elections coverage consisted of just exit polls and (accurate) opinion polls but nothing else. You would not have any sense of why things were going the way they were. It would be as bad as having just the story alone.

As investors, we are often tempted by stories, or as Damodaran would call them, narratives. Human beings love stories and narratives are very appealing. Numbers, on the other hand, are alien to most people. However, there can be no understanding of investment opportunities without looking at both sides.

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