Using Language In Portfolio Construction
The references to my writing in this post are meant to show how language can be a tool to compose narratives about individual stocks in the discovery and selection stage of portfolio construction. My goal with language is to quantify the qualitative factors of the future potential of an investment before turning to what can measured and counted in a spreadsheet. I call this forensic narrative analysis. It involves the collection of facts and circumstances to arrive at a narrative – and not the other way around.
People – the producers and consumers that make up the endless intersections of commerce – are a common focus of my writing. The stories they hear, read and perceive frame up a narrative of a world view with familiar energy in commercial terms. Some thrive in scarcity, and others stagnate in abundance. To be hopeful it is not necessary to think that the world is good. It is enough to believe that there is every possibility of it becoming good. My experience as a banker in the former Soviet Union showed me the societal consequences of shackling the free, inventive hands of the entrepreneur – and also to know the brutal shock of facts that rained down on half of humanity near the end of the last century as the old Soviet system melted away. It crumbled under wretched exhaustion and the swollen superstitions of central-planning statisticians armed with chains and acting with unrevisable allegiance to theory.
Beliefs and values weigh more in this stage of investing than the correlative subtlety of a selection of arithmetical constructs that are available for anyone with a computer to evaluate. This commitment to meaning and learning, creating a narrative of the close-knit ligatures between language and qualitative factors, is the groundwork for a security’s total contribution to portfolio risk and performance when combined with the quantitative measures of proportional allocation, correlation and volatility. The greatest risk to returns is ignoring the rewards of patience and creativity – and the inability to maintain a state of irresolution. The result should be tangible selection skill in a concentrated portfolio.
Firm valuation without the perception layer of qualitative factors risks missing a lot especially for the younger companies whose value is derived from intangible assets. For example, the time period between scientific curiosity and engineered scaling is narrowing in the field of synthetic biology. By the time an investor can calculate value creation from historical financial statements, the richest part of the opportunity has likely passed. What tools other than language and narrative are available for evaluating the early indicators of network effects, non-mean reverting data sets and increasing returns to scale? Historical financial statement arithmetic?
Finally, translating elements of the narrative into the drivers of value – and observing other investors multiply the thesis flow – can be a powerful source of outperformance.
Some things to remember when investing: since 1500 AD, population growth has grown 15x, energy use has grown 115x and production has grown 240x. (Source: OurWorldInData.org). Free market capitalism and life science discoveries are largely responsible for these achievements, and the next few decades will benefit from the same.
Here are some examples of how I have used language and narratives:
Suncor Energy (2002): “The Suncor investment taught me to derive confidence based on original, first-principles research. Also, the story told by the numbers and my notes show how important narrative is to completing investment analysis.”
Sodastream (2013): “In contrast, Sodastream’s brand experience eschews the totem of blind consumption and instead is oriented to the merits of producing something (by hand) and reaping the rewards of conservation through the use of one’s ability to reason that a beverage can be as good or better with half the sugar, sodium, calories and cost.”
Intrexon (2014): “The recent initial public offering (IPO) of Intrexon (symbol: XON) offers one of the best examples of how to use angel and VC investing techniques to make a real investment – and thereby gain some experience and insight about how investing works in the world of early-stage investing.” Related from 2020: “A Teardown Of Intrexon: The First Synthetic Biology IPO“
Tesla (2018): “While GM rehearses for its next bankruptcy, there are a constellation of signals (quantitative and qualitative) pointing to the potential for VC-like returns in Telsa’s stock in what makes it one of the best high-risk investments of a lifetime.”
Teladoc (2019): “In the area of care delivery, telemedicine is positioned to be a novel first access point into the healthcare system of the future. The only pure-play, publicly traded company in this space is Teladoc (TDOC).”
Canopy Growth (2017): “Canopy Growth, an early mover in the Canadian cannabis market, is evolving a brand-centric strategy with promising international horizons and a healthy R&D program. The company believes its focus on and investment in brands, market and product differentiation, increased cannabis supply through company and partner cannabis production platforms, and education will create a dominant global business in a rapidly expanding market.”
Blue Prism (2019): “Blue Prism PLC is among three leaders in an emerging robotics process automation (RPA) niche industry that, along with other more mature SaaS/Cloud enterprise software firms, is pioneering the ‘re-platforming’ of enterprises, across a wide swath of industries, through automation and the surfacing of new data sets that were not available just five years ago.”
SQZ Biotech (2020): “I have not witnessed the company’s CEO, Dr. Sharei, wade too deep into the limp theater of saucy TAM porn (regulations limit TAM discussions too). Instead, the company’s potential is easy enough to surmise given a little knowledge about the limitations of current cell therapies that have been afflicted with the subvirus of failure. I’ve seen this quality before in other early-stage companies where serendipity tempers expectations and moderates the evil forces of bravado. It is possible that Dr. Sharei and SQZ Biotech have opened up a new frontier of space – the intracellular space – mediated by this company’s novel membrane-disruption-based techniques.”
Click here for a list of all securities ideas I have published that could be considered by the SEC as recommendations.
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