Investing in exciting and promising prospects, such as all-healing biotech or artificial intelligence and robotics companies, where investors look for stocks with interesting stories, is all the rage right now. In the long run, however, this is not always a good strategy, as most of these stocks do not generate sustainable profits and eventually disappear into oblivion. Even the biggest companies in the fast-moving technology sector often disappear. It is an emotional challenge to resist the pull of good stories, but historical experience shows that it is more rational to avoid such stocks.
A lower number of shares outstanding is usually good for returns. Companies with a declining number of shares have outperformed the market by about 3% per year over the past 100 years. In contrast, companies with an increasing number of shares have underperformed the market. These correlations are consistent across market phases and industries. Companies that continually raise capital tend to be poor investments because they often have no or negative cash flow and are constantly dependent on the capital market.
Issuing employee options dilutes shares and hurts shareholders. Many companies simply exclude the cost of options to improve profitability. However, this increases the number of shares outstanding and dilutes shareholder ownership. Buying back shares on credit can also be problematic because higher interest rates can hurt earnings per share. Companies should fund share repurchases out of free cash flow rather than by increasing debt. Share buybacks are particularly useful in value investing, where undervalued shares are purchased. Buybacks increase ownership and future earnings without requiring shareholders to put up additional capital. This leads to an increase in earnings per share, especially when profits are rising.
It is therefore worth monitoring the share count and avoiding companies that cannot finance themselves or have large employee option programs.
The "ruse" of gut trading..I've been doing it for over 40 years now : )
ReallyMe
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@The_Unwind, If it has worked well for you so far, why not :)
The point I'm trying to make is that "story investing" alone is not a good long-term basis for stock selection.
By "story investing" I mean that the investor buys shares of companies he has heard about through their products or word of mouth. He does not understand stock market valuation, nor can he truly assess the risks of the investment. The rising prices arouse his greed. "Story investing" can work well as long as there are always new investors who are infected by the positive mood and are willing to accept even higher valuations and purchase prices. If this source of money dries up, the stocks collapse significantly and their overvaluations are reduced. Price declines and business model failures are often the order of the day.
Today's "stories" are artificial intelligence, renewable energy, blockchain, electric cars, bitcoin, digitalization, etc.
The_Unwind
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@ReallyMe, Got ya. I wouldn't touch any of those story stock with a ten foot pole. Nor would I touch the so called "me me" story stocks, that rocket up 100 ,200,300,400 %, but ultimately they almost always come crashing back leaving those who bought the hype fleeced of everything. It's really a tale of fear and greed played out on the wider audience of the "entirely gullible"