This is an excerpt from my upcoming book – Shut Up and Wait: And Other Timeless Principles to Win at Investing and in Life – which I aim to release in August 2022. Click here to read more about the book and download five chapters.
One of the most important lessons I have learned as a writer is that every great story, bestselling novel, or a blockbuster movie’s screenplay began with a ‘premise, that, in simple words, is the foundational idea that expresses the plot in simple terms.
A strong premise in writing or storytelling ideally includes three elements. First, the description of the main character or protagonist of the story – “misfit team of deep-core drillers.” Second, the protagonist’s goal – “save Earth from the impact of a large asteroid.” And third, the situation or obstacle the protagonist find themselves in – “how to destroy the asteroid the size of Texas.”
A good premise serves as both a hook for the reader or the audience and a guiding light for the writer, providing a storytelling roadmap from the start of a story to its end.
Sound investing also stands on the foundations of a strong premise. Like, value investing starts from the premise that an investor who buys stock in a company owns part of the business. While this may seem obvious, many investors “play the market” without regard to the underlying fundamentals of the companies they own. They lose the premise that will do them good in the long term while trying to win in the short term. And this is because, instead of a sound ‘premise,’ they create a false ‘narrative’ and get overly wedded to their particular ‘story’ about the markets or their investments. In fact, they start fitting a story to what they already believe in, which is largely a result of what others around them believe in.
Consider the dotcom bubble of the late 1990s. I was not an investor then, but I have heard several stories about how a large majority of investors believed in the then common view that because the internet economy were going to change the world, traditional accounting and valuation methods were irrelevant to value the businesses. The result was that a form of madness took hold as investors chased the valuations of many dot com startups, without any revenue or profits, to ridiculous levels.
Some such sort of madness was seen as recently as late 2021 when we saw a spate of IPOs from the new-age startups that were seen as torchbearers of new India, again at valuations that disregarded rationality. And investors again fell for the narrative, only to pay a price quickly.
Remember – a premise is not same as a narrative.
When you buy a stock, or any investment, you must have a premise – the foundational reason(s), the ‘why?’ for its place in your portfolio – not a narrative that you try to forcefully fit in to what’s hot and in the limelight.
A premise is a reason why a stock will go up over the long run, because the underlying business will grow profitably because the management will allocate capital efficiently, and the market will value that business at current or higher multiples. A narrative, on the other hand, is usually a story you try to fit in to justify why a stock will go up, which is largely because it has gone up in the recent past, and you probably have already made up your mind to own it, and now you cannot go back because you have already committed to the idea in your mind.
Like a storytelling premise, an investment premise also has three elements – the protagonist (you), your goal (wealth creation, or financial freedom) and the obstacles you may face (your emotions of greed, fear, and envy, or the investment going bad).
Without a sound premise, the protagonist of a story may end up with wrong goals and wrong solutions. It will be a flop. In the same with, without a sound investment premise, you may end up owing just a ‘stock’ that you would flip in the next few minutes or days, not an ‘investment’ that you would be willing to own for a few years so that it contributes to your journey of wealth creation and financial freedom.
That’s about it from me for today.
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