The Power of Stories in Wall Street

I love stories, and I have since I was a little kid. I could get lost in books full of stories about astronauts, cowboys, and pirates. Especially pirates. I still love stories well told.

I am still likely to be found reading a novel by a favorite author that tells a great story most evenings.

Most Americans love a great story. Some of our greatest heroes and legends are storytellers like Mark Twain, Will Rogers, Louis L’Amour, and Walt Disney.

Wall Street also loves a good story. Being on the right side of the story can make you a lot of money. If you stick with the story after it has been revealed as a Macbeth (sound and fury signifying nothing), you can and will lose a stunning amount of money quickly.

I have been around for a long time, so I have heard some great stories about Wall Street (and its satellite operation in Silicon Valley) over the years.

I remember when everything with “electronics” in the name would become a blue-chip stock and soar to the moon. The correction in 1984 ended that one.

Then there was the idea that it didn’t matter how much you borrowed to do a buyout or what the interest rate was, as long as you could cut the fat and sell off the unwanted divisions. The crash of 1987 and mini-crash of 1989 shredded that one.

Profits didn’t matter, only eyeballs and clicks.

Anything that could be done to expand homeownership was good for America.

If we owe the money to ourselves, we can print as much as we want.

Electric vehicles will replace internal combustion engines by 2030.

The sexier the story, the easier it is to draw in buyers hoping to cash in on the latest, greatest company that would change the world.

Remember 2020 and early 2021, when we would all do everything from home, have all our supplies delivered, and take space travel vacations? When we did leave, we would travel by electric unicorn to our destinations.

Lenders could use machine learning to determine which deadbeat borrowers would change their ways and repay a loan, earning profits beyond imagination.

The problem with stories is that the public all too often gets caught up in them and doesn’t discover the punchline until it’s too late.

WorldCom, Enron, Pets.com, Theranos – all of them were great stories that eventually destroyed enormous amounts of wealth and made a handful of short-sellers rich.

Remember Nikola (NKLA), the electric drivetrain manufacturer that was going to revolutionize transportation? Everyone loved the stock a few years ago. It has fallen about 99% since the peak in 2021.

How about Workhorse (WKHS), the company that was going to make electric cars, trains, and planes? It has fallen from over $200 to under $1.

Pinterest (PINS) was going to let us all share the photographs we took while sitting around the house with everyone in the world. As it turns out, no one cared, and the stock dropped from almost $90 to under $20 in less than a year.

A year ago, micromobility.com (MCOM) announced its plans to transform transportation, especially last-mile delivery. It delivered massive losses as the stock price fell from $12 to $0.01.

How about Snowflake (SNOW), the big data company sure to go to the moon because somebody at Berkshire Hathaway (BRK-A) bought the stock? The story was more attractive than the business, at least for now, and the stock fell by almost 50% in just a few months.

Avoiding the story stocks can help you not destroy your account value in the blink of an eye. Shorting them can make you a ridiculous amount of money if you are disciplined in your trade management.

I crunched a lot of numbers, trying to identify the stories that were ready to implode, needed to be avoided, and could be shorted. I found a few hundred ways that did not work. I found one that has worked consistently for a couple of decades now.

First, find a list of stocks trading for over ten times revenue. Remove all the Real Estate Investment Trusts and clinical-stage biotech companies. There are reasons for this, but it would take thousands of words and bore you beyond tears.

As a wise old trader once told me, hanging around in barrooms after 10 pm and owning stocks trading more than ten times sales were excellent ways to find trouble of the worst kind. It may not always lead to trouble, but when it does, it gets ugly quickly.

Next, look for companies with poor fundamentals where operations and financial conditions were declining. The story might be great, but the business is less than wonderful.

Next, ensure the short sellers have increased their position as the stock increases. Short sellers get a bad rap, but the simple truth is that the average short seller is brilliant. If you are going to sell short a popular story stock, you are either very smart or you are broke. There is no in-between.

If the shorts are piling on, you have a bunch of intelligent people who are pretty sure the stock is going down big relatively soon.

Has it worked?

Over the last 25 years, the S&P 500 has returned 8% annually with the dividends reinvested. $10,000 would have turned into $72,200.

A portfolio of stocks meeting these characteristics, rebalanced quarterly, would have had negative returns. You would have hundreds and maybe even thousands of opportunities to short stocks that collapsed by 50% or more in a short period of time.

The last 11 years have been fantastic for stocks with a compounded return of over 12%. The grand turned into over $33,000 with no effort in an index fund.

A strategy using this stock, owning the stocks on our shortlist, lost money. Using them as a list to apply technical tools could have made you a fortune.

You took the market and identified a small handful of richly valued companies with deteriorating fundamentals and a high probability of declining.

Using a portfolio approach of shorting the 10-25 stocks with the highest short interest is also a winning strategy that would make a solid way to run a long/short portfolio.

There are some exciting names and great stories on the current list. Next week we will examine a few candidates to take the big plunge or possibly lead the market lower.

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If you want my picks before that, you can find them here, where the stock I recommended popped 30% in 1 month after I picked it this year.

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