9
Nov
2018

Heroes and Xeros

I’ve been thinking about “story stocks”. In case you don’t know “story stock” is normally a term of abuse among value investors. It means companies like Xeros or Cap XX, which have an exciting potential “story” often about a new technology but fail to deliver profits. To try and understand why we are drawn to these types of stories I’ve been reading up on what makes a good narrative – from Carmine Gallo who helps TED talkers to Phillip Pullman who writes children’s books. I’d like to understand the connection between stories we enjoy and why we overpay for “story stocks”.
My reading suggests that we are hardwired to like stories, and to find meaning in events, particularly struggle in overcoming adversity or triumphing against long odds. Philip Pullman also make the point that we adopt the perspective of the character that the story begins with….once we identify with a hero, we are on his or her side and find it hard to change our minds.  Something that modern behavioural economics/psychology would recognise.   There’s plenty of evidence to suggest once we buy into a “story stock” we find it hard to change our minds, even if there is evidence accumulating that things are not going as well as we originally hoped.

This can be manipulated or confounded.  “A Hero of our Time” by Mikhail Lermontov is such a great story, because the author plays around with the chronology and starts from a distant and unsympathetic perspective of the “hero” Pechorin to confound us. Pechorin may be an unlikely hero, but he is certainly a memorable one.
But I digress.  On one level we know that “story stocks” are unlikely to succeed, but we want to believe in them anyway.  Probably for the same reason that if the giant Goliath had beaten the young shepherd David, then it wouldn’t have been a memorable story. Why do we want to believe in unlikely events, when we know in bleak reality that most times the giant kills the shepherd boy? It’s normally a safe bet to put your money on the giant. Why do we want to be convinced of probabilities that are unlikely in everyday life?
My conclusion is that we like to identify with heroes who have obvious flaws but also hidden strengths.     .
Story works something like this:

  • Probability of Saul beating Goliath: 33%
  • Probability of unknown shepherd boy beating Goliath: 5%
  • Probability of shepherd boy called David with God of the Israelites on his side beating Goliath: 100%

Story stocks are “underdogs”, unlikely to succeed, and we tend to pay a high price for them using historic accounting numbers like sales or profits. But maybe we like to believe we’ve spotted a “hidden strength” or competitive advantage which no one else has spotted – that the mild mannered newspaper reporter is actually superman.

Just like an angel

So I’m going to suggest that for “story stocks” it is worth focusing even more closely on the narrative that management tell. The numbers just aren’t that useful, but maybe a close reading of the text is? I like the idea of focusing on text, something that many value investors would ignore. But secondly not all story stocks are alike – interestingly Charlie Munger suggested a couple of years ago that it should have been easier to spot the success that Google would enjoy when compared to Amazon.  That is, with hindsight he wasn’t that upset than he missed Amazon, but he was kicking himself for missing Google. https://buffett.cnbc.com/2018/04/02/over-time-buffett-softens-stance-on-tech-stocks.html
Both companies were story stocks, but story was more obvious at Google.

I was tempted to do a comparison between LoopUp and Xeros, but given that Xeros share price has already fallen by around 90% maybe that’s cheating: we know how the story ends. It would be better to take two story stocks that have yet to deliver, but still trading on high altitude valuations and suggest which one I’d back, based on the story alone.

Float like a feather

I’ve chosen a couple of examples both listed on AIM: LoopUp (which does conference calls) and Learning Technology (which does online education). Both companies have low level of profits, low returns on capital but fast growing sales, and a lot of future “hope” in their valuations. They are both trading on more than 10x sales, and more than 30x forecast earnings according to Stockopedia.
I’ve just copied and pasted from the most recent Annual Reports. Let’s just look at the first 3 sentences. Have a read and see if you agree with my analysis and thoughts on the future prospects, first Learning Technologies:
“LTG’s aim is to create a group of market-leading businesses providing complementary services in the fast-growing learning technologies sector to form an international business of a size and scale that is able to meet the demanding expectations of corporate and government customers.
This strategy is being delivered through a mixture of ‘best in class’ acquisitions that will help us create a comprehensive e-learning solution for our customers, strategic partnerships to deliver ‘blended’ learning solutions combining digital and more traditional forms of learning, as well as through targeted investment in internally generated intellectual property and the extension of best working practices to deliver strong organic growth.
We continue to pursue our strategy of helping organisations adopt learning at a strategic level.”

The first couple of sentences are really hard to read, they are long winded. That is there is nothing I’d disagree with, but that’s the point. Can you name a business that has a “market following” rather than “market leading” strategy? Which company deliberately makes “worst in class” acquisitions? Translating the clichés of the first two sentences suggests the company is in e-learning, and is going to grow by investing in their own business and also by buying other companies. If management wrote that in plain language and short sentences, they would come across as distinctly average I suspect. 
The third sentence is OK, their strategy is “helping organisations adopt learning” but what exactly are they doing differently to the competition? What are the trade-offs in their strategy?
Instead I much prefer the LoopUp approach. Which starts with the problem, and even references the assertions they make with sources.

“Conference calls have become an important facet of everyday business, now accounting for 50%(1) of all voice communication.

And yet after 30 years of innovation, nearly 70% of enterprise users are still dialling in with phone numbers and access codes(2).

They’re not using any software at all for a better experience.”

What’s more, after LoopUp management have explained the problem they’re trying to solve (annoying conference calls) – they also explain why the problem still exists and more obvious approaches have failed.

“Dial-in may well be a poor experience, but it’s the safe bet. Plenty of feature rich software products have tried to drag conferencing out of the ‘dark ages’. And they’ve had some success with tech-savvy early adopters and specialist user groups, such as IT and Training teams.
But, none have ‘crossed the chasm’ into the majority of professionals who are intimidated rather than impressed by their bells and whistles. As a result, most users continue to play it safe, trudging on with the poorer experience of dial-in. IT decision-makers remain frustrated as well, paying for software licences that go unused.”

Then they go on to explain their solution, and what they’re doing differently to the competition. Their hidden strength or “superpower” if you like. At first glance you might dismiss it, but thinking about human nature their approach seems to be common sense – to me at least.

“Rather than trying to wow early adopters with a myriad of features, LoopUp takes a minimalist and prescriptive approach to its product strategy and design.
LoopUp is a premium remote meetings solution specifically designed for the majority of professionals – the risk-averse mainstream, who need something that just works. We think this is essential if you’re to entice the 70% away from dial-in.”

So ignoring the numbers in the accounts, the “story” at LoopUp seems much better articulated. They are deliberately keeping their product simple to appeal to the risk averse mainstream. When it comes to stories people like fantastic events, when it comes to organising conference calls, they want a safe bet. I don’t own either company at the moment, at the moment I just can’t bring myself to pay 10x sales for any company.  Regardless of valuation, I think on “story” alone, LoopUp wins.  Let’s see how they do in future.

I want you notice

It’s possible that LTG also have a hidden story, they are just not very good at telling it. Or maybe they don’t want to in a public document like an Annual Report, because their competitors might take notice? Maybe. To me the whole point of a good “story stock” is that it doesn’t appeal to everyone. There should be an obvious reason to dismiss or underestimate it – obvious but wrong.

 I’m a creep, I’m a weirdo

Like a band that’s not too mainstream or crowd pleasing, the lack of universal appeal is an attraction in itself. For an “underdog” to be an “underdog” there SHOULD be an obvious flaw that means many in the crowd underestimate it, as Goliath and the Philistines underestimate David.  That’s certainly true for most of my successful investments, from Bank of Georgia to Burford and Games Workshop. There were superficial reasons for not liking or understanding their story. A Prisoner of the Caucasus, A Hero of our TimeHadji Murat,  some memorable fiction may have come from the Caucasus, but it’s not an obvious place to look for a good banking story.

Let’s see what happens with LoopUp and Learning Technologies – but my thinking is that there’s more useful information in the text than in the numbers for both companies. And on the story alone, I much prefer LoopUp.
A second observation is that with MIFID II, companies are going to have to get better at telling their own stories. They can’t rely on brokers and analysts to do it for them. Explaining what problem they are trying to solve. What they are doing differently. What challenges they are overcoming, and explaining how they can kill Goliath. Maybe there’s a way to automate this? But for now, I still appreciate a good story when I come across one.

 

Photo by Dmitry Ratushny on Unsplash

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