If Narrative is story, Numbers is history! If Narrative is the fabricated future, Numbers is the irrefutable past and present. It is the stark reality of a stock captured by a wide variety of hard facts and figures – company market share, revenue, margins, return on capital, growth, capex, dividends, valuation multiples, etc.
There is a dynamic inter-linkage between Narrative and Numbers. More often than not, the driver of most investment decisions is the Narrative. But whether the investment will be successful or not depends largely on the extent to which the Numbers track the Narrative.
The four quadrants can be explained as follows –
• Strong-narrative-Strong-numbers (MULTI-BAGGER): If a strong Narrative is followed by strong Numbers, the stock will most likely emerge as a multi-bagger, led by earnings growth and valuation re-rating.
• Weak-narrative-Strong-numbers (CREDIBILITY GAP): At times, stocks have strong relevant Numbers, but not much of a Narrative to accompany them. We may call these cases Credibility Gaps. Markets tend to be circumspect of the reported Numbers as unsustainable or even “too-good-to-be-true”. So, valuations may remain modest, and yet such stocks tend to outperform led by sheer earnings growth.
• Weak-narrative-Weak-numbers (UNDERPERFORMER): This is self-explanatory.
• Strong-narrative-Weak-numbers (NARRATIVE TRAP): Many times, stocks come accompanied by a strong Narrative. But the reported Numbers just fail to live up to the Narrative. We call these Narrative Traps. For some time, such stocks may outperform as the Narrative drives up valuations. However, if the Numbers fail to match up within a reasonable time, the stocks will eventually end up as deep underperformers.
Like stocks, like markets: India – Multi-bagger or Narrative Trap?
The Narrative-Numbers framework can be applied not just to stocks but to markets as a whole. Take India for example.
Ever since the new government came into office in mid-2014, the Narrative for Indian equities is strong – visionary PM, business-friendly government, far-reaching reforms led by absolute majority in Parliament, one of the fastest growing economies in the world, favorable demographics, falling interest rates, and so on. As a result, market valuations are rich with TTM (trailing twelve-month) P/E around 20x, 10% higher than long-period average.
However, the Numbers for India remain persistently Weak – investment cycle has not picked up, the banking sector is laden with bad loans, corporate earnings growth are flat for the last two years, and further downgrade possibility looms.
Post-demonetization, the Numbers are expected to improve beginning FY18. If this happens, the Indian market will be a long-run Multi-Bagger. If not, it may well prove to be a Narrative Trap.
Conclusion – Beware of the Narrative Trap
In his classic book, “Thinking, Fast and Slow”, Nobel prize-winning behavioral economist Daniel Kahneman says,
“A compelling narrative fosters an illusion of inevitability.” A Narrative largely involves the future which is fraught with uncertainty. Hence, the reality (i.e. Numbers) may be significantly different from expectation (i.e. Narrative).
In equities, “a compelling narrative” usually means super-rich valuations in anticipation of robust numbers ahead. Many IPO offerings also come wrapped in compelling narratives. Investors need to beware of such potential Narrative Traps. If one has invested in a stock based on Narrative, and the Numbers fail to live up to expectations within reasonable time, it is advisable to cut one’s position even at a small loss. Holding on to the stock with hope could lead to a much bigger loss and deep underperformance.
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