I think there is so much cult of personality. It is one of the ways in which the business world is not so rational, and is so emotional.
People are believers in other people, and sometimes because those other people really have figured it out and sometimes because those people just have a really compelling way of presenting their vision.— Bethany McLean, The Knowledge Project #85
At the end of the day, we sit around the campfire and tell stories.— David Mamet, Masterclass
Understanding narratives is an important idea, especially today. No one has time to look at the data — sounds boring and I’m sure it checks out.
We need a story.
Why is this important?
If you control the story, you can influence the people who believe that story, because what and who you listen to influence what you do.
Historically, stories spread through real campfires, reaching a few thousand people. Then, books and city campfires, reaching a few million. Now, Zoom & YouTube campfires, reaching a few billion.
The potential audience is big.
I couldn’t wait to read Narrative Economics by Robert Shiller, because I thought he was going to roast WeWork, Tesla, Theranos, Blue Apron, Snapchat, etc.
The criticism would obviously have nothing to do with their products, which we mostly like. It would be directed at their dependency on shareholders’ belief in their narrative of the future, and how they became more valuable as they lost billions of dollars.
I pictured Plato shouting into his allegorical cave, “The shadows are LOSSES!”
In the finance world, this money-losing-present-for-a-blissful-future theme is VERY on-trend, but Shiller took a different, broader approach with his book. This choice both satisfies and disappoints because it seems like he simultaneously covers a lot and barely scratches the surface.
Shiller’s book is great and worth reading, but I want to talk about the book he didn’t write, because we want to know what’s up with those money-losing companies.
How Much Would You Pay to Lose Money?
We know that human nature doesn’t change because we have the same problems the philosophers had thousands of years ago (better means to the same ends).
People didn’t save money for a long time. Now they do. So…maybe that isn’t firmly rooted in human nature….maybe it’s us…learning.
When someone would rather have $10,000 today than $50 million in 40 years, the behavioral economics crowd calls this time inconsistency. If you want to sound like you wrote the textbook, you call this “hyperbolic discounting.”
Well, if you read the Econ textbook and work really hard at designing your life, you may decide that hyperbolic discounting is for suckers and you are going to value the future appropriately.
Using this skill, you look at a few companies. You remember that the way to value a company is by using a Discounted Cash Flow model (“DCF”) like the simplified ones below.
You take all of the cash it’s ever going to make and see what you would pay today for it based on the other opportunities you have available.
Company A (Makes Money Every Year)
Everyone likes Company A. Reliably makes money, easy to value. I think of Walmart.
However, for it to GROW beyond Year 5, it might depend on a narrative: “We are going to compete with Amazon Prime.”
There are only three ways a company can become more valuable from where it is today (beyond earning its discount rate):
- The expected cash flows increase
- The discount rate decreases
- You throw the Discounted Cash Flow model in the trashcan and say, “Hey, do you want to get rich or stay poor!?”
FINALLY, I GET TO TALK ABOUT MONEY LOSING COMPANIES BECOMING MORE VALUABLE BECAUSE THAT IS NOT INTUITIVE.
I keep saying money-losing companies. People that invest in them are probably smarter than me. But, how can something that loses money be worth anything?
The obvious implication is that it will eventually stop losing money and start making money.
Almost everyone will then ask the next logical questions: When, and how much?
Company B (Losses, Followed by Positive Cash Flow)
Company B needs a narrative. Nobody loves the idea of losing money for years before making any. Someone has to fund losses. Writing checks is painful. You will eventually stop unless you believe the narrative.
But, this is a critical point: Company B is worth more than Company A. The later payoffs more than offset the initial losses.
Amazon is the prime example (had to) of a company who has executed on this strategy. It required a belief in the narrative that they could flip the profitability switch on in the metaphorical Year 4 (in reality, it took Amazon ten years to post a full-year profit). The problem is, not enough people recognize how unusual it was for them to accomplish this.
Is this a triumph over time inconsistency and hyperbolic discounting?
Company C (Indefinite Losses)
Then there is Company C. Losses with no end in sight.
This entire essay can be distilled into the question: Can you distinguish between Company B and Company C in Year 0?
This requires an understanding of the business and how it will actually make money. If it costs you $10 to produce ten cups of coffee and you can sell them for $2 each, you have a sustainable business as soon as you find six customers.
If it costs you $150 to acquire a customer and send them a home meal kit, and they pay you $60 for it, you better tell a good story.
In Silicon Valley, it seems that business plans — a narrative of how one intends to make money — are once again far more valuable than many actual businesses engaged in real world commerce and whose revenues exceed expenses.— Seth Klarman, Baupost Group
Case Study: Teladoc
If I asked you to give me $17 billion for a company that has lost an average of $87 million a year over the past five years, you would ask if I was off my meds.
Enter the narrative and the meds.
Next, I tell you about a company that was the largest and most trusted global leader of comprehensive virtual healthcare services. They specialized in virtual doctor visits. They aim to provide high quality healthcare at a fraction of the cost from the comfort of your home. Can you think of a company better positioned for the current environment?
What if I THEN told you, they were the same company…
At the time of writing, Teladoc (NYSE: TDOC) is trading at $211 a share, or $17 billion.
It gets better.
There is nothing wrong with a company that temporarily loses money. In fact, that is one of the only ways to get new customers’ attention in a hyper-competitive world.
However, if someone tries to sell a money-losing company to you, you want to be certain that you have a better insight into how it will become profitable than the seller. We want to avoid being the sucker and holding the proverbial bag.
I used Teladoc precisely because there is a good narrative, the outcome is uncertain, and the stakes are high. If you can accurately figure out whether the narrative is true or false and answer the following questions, you can make a lot of money. Can they achieve profitability? If so, when and how much? Is it Company B or Company C?
The big problems start when people stop caring about the answers to these questions and people instead treat companies like fiscal hot potatoes. What if management has no intention of figuring out whether it actually will make money, or sticking around to find out?
What if they tell you that directly?
The biggest source and beneficiary of narratives in public markets today is Tesla, which has become both a very expensive company and the world’s most interesting new religion.
One narrative involved the company’s stock-split, which is effectively trading a $100 bill for five $20 bills.
Twenty-year-old girls on TikTok explained how this was an opportunity to make free money since the stock would be cheaper. The stock went up on the announcement of the split…presumably influenced by people believing some version of this, or believing people will believe it. Ben Hunt at Epsilon Theory posted a quick read on this today: The Game of Tesla.
My favorite Tesla narrative to-date: Elon Musk is going to space to mine gold off asteroids.
Think about this, at least one person in the world bought Tesla’s stock solely because of that story.
Gold miners have a hard enough time making money on earth.
So, who came up with that narrative? It looks like the Winklevoss twins (those guys from The Social Network) did. In a video with Bartstool Sports founder & entertainer, Dave Portnoy, they used this narrative to promote their own narrative: That Bitcoin is the only finite currency.
Keeping track of all this makes me feel like I am in Inception.
Conversations about Tesla and Bitcoin remind me of political conversations. It would be interesting if it was a truth-seeking exercise. Instead, it seems to be an emotionally-charged cage match with people talking past each other.
At Tesla campfires, it seems the bulls have little interest in the questions above, like when will the company make money and how much. Company B or Company C? Who cares? Elon Musk is a genius.
When there is no traditional way to value something, you must value it in a non-traditional way, which introduces subjectivity and imagination. Unlike money, people are good at supplying these in infinite quantities.
No profits mean unlimited potential profits. Actual profits are limited and can be measured, thus much smaller than infinite.
It almost feels too obvious to say, but Tesla and Bitcoin have two fundamental things in common: They both have a viral narrative and the people buying them want to get rich quickly, without working.
If the Bitcoin-as-a-currency story persists and enough people believe it, through a chicken-and-egg type circularity, it will actually become true — like the girl on TikTok being so wrong that she was right.
Similarly, Tesla just issued $5 billion of new stock, taking advantage of its current valuation. This is similar to you and I having a lemonade stand that is barely making any money, but people think it’s worth $400 billion. We look at each other and say to the market, “Wait, you guys will give us $5 billion for 1% ownership in our company? [holds in laugh] Sure!”
So far, it looks like I am implying narratives are only manipulation devices. This is an unfair appraisal because there are indispensable benefits to narratives:
- Everyone wants to be involved in an important story (e.g. Being able to say you were an investor in the company that colonized Mars)
- They allow us to connect with other people participating in the same story (e.g. “Holy smokes! It’s almost embarrassing how rich we are getting from our Tesla stock.”)
- Simplify complex topics (e.g. Electric cars are the future.)
Here is what I think happens, based on what I’ve learned about Scientology: We let our ego get attached to these stories. We would be embarrassed to admit we trusted a bad leader or a false narrative and what that supposedly means about us. This is why changing our minds about anything is hard.
Regardless of the story, we should look at the storyteller’s motives. More importantly, we should try to constantly look at the world the narrative is describing, as it really is. One of the main goals of survival is to conserve energy, and cognitive energy is no different. So, a huge benefit to a narrative is its ability to concisely convey a lot of information.
When it is accurate, it is valuable.
This begs the question: What is the difference between a false narrative and a true one? Making promises and keeping them (execution), evidence, and time.
What else could it be?
- Narrative Economics by Rober Shiller (2019)
- “He’s Full of Shit!” How Elon Musk Fooled Investors, Bilked Taxpayers, and Gambled Tesla to Save SolarCity (Bethany McClean, Vanity Fair, Aug. 2019)
- Tesla Agnostic (Ramp Capital, July 2020)
- The Game of Tesla (Epsilon Theory, 2020)
- How Blue Apron Became a Massive $2 Billion Disaster (Feb. 2020)
- “You Don’t Bring Bad News to the Cult Leader”: Inside the Fall of WeWork (Gabriel Sherman, Nov. 2019)
- Bad Blood: Secrets & Lies in a Silicon Valley Startup by John Carreyrou (2018)
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[…] You: These days it seems like it is less about the actual or likely cash flows. It seems more like it is beliefs all the way down. As you’ve said before, the narrative is more important than the truth. […]