What it means
Most shares are valued on a mix of what the company earns today and what it is expected to earn later. For a story stock, the second part dominates.
The business may have little revenue, or losses, but investors pay a high price because they believe it will become very large. Typical examples are early-stage technology, drug development, electric vehicles, mining exploration and new forms of financial services.
The common feature is a large potential market combined with limited proof. This makes the share price highly sensitive to news, rumours and the mood of the market.
The attraction is the potential for large gains, and the danger is that the price rests on belief rather than on evidence. If a trial fails, a customer leaves or funding dries up, the narrative can collapse and the price can drop by half or more in days.
Because there is little profit to support the valuation, there is also little to stop the fall. Good analysis breaks the story into testable parts.
What must be true for the story to work, how much cash will it consume before then, and what milestones will show progress? A company with a clear plan, enough cash to reach its milestones and a credible team is a different proposition from one with a slogan and a presentation.
Not every story stock is a bad investment, and some turn into great companies. The point for non-specialists is to recognise the type, to size any investment so that a total loss would be bearable, and to be wary when the price depends on the same story being repeated by people who benefit from it.
It also helps to separate the story from the share price. A strong story can be true while the shares are already too expensive, because the price may reflect years of success that has not yet happened.
Ask what return you would earn if the company delivers exactly what it promises, not only what happens if it does better.
In practice
Real-world examples.
Example
A biotechnology company with no revenue sees its shares triple after early trial results look promising. Analysts value it at $900,000,000 based on the chance that the drug is approved. A later trial fails, and the company's value drops to $150,000,000 in a single day.
Example
An electric vehicle start-up has built only prototypes but announces large pre-orders. Its stock market value exceeds that of established carmakers with real sales. The finance team at a potential supplier reads the accounts carefully and insists on payment in advance.
Example
A mining exploration company announces promising samples from a remote site, and the shares double. The company has not yet proven that the deposit can be extracted at a profit. An investor uses a small position, treating the holding as a speculative bet.
Case study
Seen in the real world.
Aurora Fuel Cells is an illustrative, fictional company that has never made a profit and has revenue of $2,000,000 a year. It describes itself as the future of clean energy, and its shares trade at a value of $1,500,000,000.
The company burns $60,000,000 a year and has $120,000,000 in cash, so it has about two years before it must raise money again. A finance professor following the stock notes that the share price assumes the company will eventually earn hundreds of millions in profit, which requires several things to go right.
When a large customer delays an order, the story weakens, funding becomes harder and the shares fall 60%. The illustrative lesson is that a story stock should be judged by its cash runway and milestones, not only by the attractiveness of the narrative. A plain list of what must happen in the next 12 months, and what each step costs, gives a far clearer view than the company's own presentation.
Watch out
Common mistakes.
- Treating a good story as proof of a good business, when the numbers must eventually support the narrative.
- Putting too much money into one story, when a failure could cause a total loss.
- Ignoring cash runway, which shows how long the company can survive before needing new funds.
Questions
People also ask.
What is a story stock?
It is a share whose price is driven mainly by a compelling narrative about the future, rather than by current earnings or cash flow.
Are story stocks always risky?
They are usually higher risk because the price relies on belief, but risk varies with the cash the company holds and how close it is to proof of its claims.
How can I judge a story stock?
Ask what must be true for the story to work, how much cash is needed to get there, what milestones will show progress, and who benefits from promoting it.
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