Wednesday, February 21, 2007

What is the "sexy story" about this stock?

In the world of Wall StreetCraft, people like to talk about stories. What is the sexy story for this stock? They would ask, or has this industry got an interesting story?

Translated into English, it basically means this: Tell me why you are buying this stock and make sure it's a fairy tale that everybody likes.

Peter Lynch, the star fund manager for Fidelity some years back, gave this one piece of advice that has got stuck inside my head ever since I read it. If you cannot explain the why you bought this stock into three sentences, then probably you should not buy it in the first place.

For those who have never heard of Peter Lynch, well I suggest you go look him up at Wikipedia. And don't forget to come back here and click on that Amazon link to buy his book!

So the moral of the story is this: Know why you are buying the stock. The reasons should be simple and easy to understand.

In other words, when you buy a stock, make sure that you know its "story". It should be sexy, it should make people say "wow" and make monkeys drool, as if they see truckloads of bananas. But it should also be realistic and the earnings are real.

Over the years, sell-side clerics in the World of Wall StreetCraft have mastered the art of story-telling. They can really spin an infinite amount of fairy-tales and all of them promise a happy ending.

Things like replacing all wires and connectors in the world with Photonics Technology (i.e. light or photon beams), Satellite Mobile Phones (guess most pple remember this one, and the co called Iridium went bust) and my favorite: 3D Holographic Video Phonecalls: some real life technology akin to Princess Leia sending the distress message through R2D2, which was later picked up by Luke Skywalker in the original Star Wars. Too sexy for for your money huh?

But, ultimately, I personally think there are only 3 kinds of stories around. Those that are real and can make you money and then you REALLY live happily ever after one.

1) Growth story: Simple and straight forward, the company has got growth and it is sustainable, valuation is also still reasonable (not PER of 50 or 80x, but say around 15x). Note: the stories listed above (e.g. 3D Holographic Video) sound like growth, but there is a different name for them. They are called concept stocks. There is only a concept, no earnings or sales to justify the story yet.

2) Restructuring story: Company has a good business but somehow cannot generate profits. i.e. very strong sales but no earnings. But one fine day, new management steps in and decide to do something about it. OP margin doubles. i.e. earnings also double and stock price quadruple. Shiok right?

3) Value story: This story can manifest itself in various ways but the basic idea is that you are buying something worth $100 for $40 or less. The difference between this story and the growth story is that the company usually has little visible growth but still the business is very solid and generates good cashflow.

See also Brokers cannot be trusted
and What drives stock prices?
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