Storytelling and investment! The two words sound quite out of place together, don’t they? Well, yes, they are two concepts that are poles apart and so not overlapping, at the first look. We do understand that narrative and numbers are controlled by totally different parts of the brain, and we have been made to believe that a person can only have one dominant part of the brain, either left or right.
The storytellers have a different world altogether and they may go anywhere in their fantasyland. This is a risky idea when it comes to business or investment. However, in the real world, storytelling and investment form a fairly good couple. When narrative is efficiently used to depict the story of a business, it can have highly positive impact on the investment decisions and numbers.
The relationship has been explicitly depicted by Aswath Damodaran in his book, “Narrative and Numbers: The Value of Stories in Business.” Aswath states,
“What comes more naturally to you, storytelling or number crunching? It is a question that I start my valuation classes with, and for most of us the answer usually comes easily, because in this age of specialisation, we are forced to choose between telling stories and working with numbers early in our lives, and once that choice is made, we spend years not only increasing our skills in that chosen area but also ignoring the other. If you buy into the common wisdom of the left brain governing logic and numbers and the right brain controlling intuition, imagination, and creativity, we are using only half our brains in our daily lives. I think that we can become better at using our brains, if we can start working on the side that we have let lie dormant for so long.
But we seem to be missing a point here. Investment, in itself, is an art. It does require creativity, intuition and imagination, as much as any other form of vocation. A person who is good with narratives can use his capabilities to drive an excellent investment or business decision, and vice versa.
For centuries, knowledge was passed on from generation to generation through stories, told and retold, perhaps gathering new twists, as they tend to do, with each retelling. There is a reason that stories have such a hold over us. Stories not only help us connect with others but, as research indicates, they are far more likely to be remembered than numbers, perhaps because they trigger chemical reactions and electrical impulses that numbers do not.
These are the scientific evidences to prove the same. Numbers tend to be forgotten more easily than stories. It is often believed that numbers provide more precision, objectivity and credibility to a business decision but, at the same time, numbers can be highly disillusioning.
While every valuation starts with a story about a company, and the numbers flow from that story, the story itself will change over time. Some of this change will be the result of macroeconomic shifts, as interest rates, inflation, and the economy map out their own paths. Some will be the result of competitive dynamics, as new competitors enter, old competitors modify their strategies, and some competitors drop out of the market the company is targeting. Some story shifts can be traced to changes in management, both in terms of personnel and tactics. The bottom line is that it is hubris in storytelling (and the number crunching that emerges from it) to assume that the story you tell will remain immune from the real world.
This is when the mid-way approach works most efficiently-the approach of combining the strengths of storytelling and numbers! It is easier to remember the stories but they have the tendency to wander into the fantasy, and the numbers keep the investor more disciplined but bring bias and intimidation. The solution is easy; to bring storytelling and numbers closer to each other through the bridge of valuation.
How can you adapt and control storytelling in the context of valuing businesses and making investments? You begin by understanding the company you are valuing, looking at its history, the business it operates in, and the competition, both current and potential, it may face. You then have to introduce discipline into your storytelling by subjecting your story to what I call the 3P test, starting with the question of whether your story is possible, a minimal test that most stories should meet; moving on to whether it is plausible, a tougher test to overcome; and closing with whether it is probable, the most stringent of the tests. Not all stories that are possible are plausible, and among all plausible stories, only a few are probable.”
Thus, narratives and numbers can be used in conjunction for best results. Valuation helps the storyteller to see the parts of his story that are impossible or fantasy-driven, while helping the number crunchers to detect where their numbers do not depict the right story and correct right there. A good valuation combines the story of the business with the numbers of the business and gives a clearer, more accurate picture.
The most successful approach is to first create a story of the business being evaluated, how it is seen to be evolving with time. Now, the narrative needs to be tested to find if it is possible, plausible and probable. The next step is to combine this story with the numbers of the business, keeping in mind that each number must be backed by a story. Next, all these stories and numbers are combined to form a valuation model which provides the most correct value of the business. In this way, this approach combines the strengths of storytelling with that of numbers for the best outcome. Win-win!!!