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1-Page Summary of Narrative and Numbers
“Two Tribes”
From a young age, people tend to divide into two distinct groups: those who are good at math and those who are better at writing. Children who are adept with numbers often become engineers or accountants. Those who struggle with math but thrive on words usually study history or literature. As they enter the workplace, these two groups form separate tribes that can’t communicate well with each other.
Managers and investors must understand the difference between numbers and stories. If a business valuation is not supported by an underlying story, it will seem soulless and untrustworthy. However, if a story lacks numerical evidence to back it up, then there’s a chance that it might be a scam.
We can think of the Ferrari company in several ways. We could describe its growth rate and profit margins, but that would only appeal to people who like numbers. Another way is to talk about how it makes small, prestigious cars for high prices. That story would be memorable, but not very informative. A third way is to combine a narrative with some numbers so we can see why they make sense together: The low growth rate reflects the fact that they want their cars to remain scarce.
Narratives
Stories are powerful tools for persuading people. Scammers use tall tales to take advantage of people and steal from them, but good stories can be used in the business world as well. A company needs a story in order to get investors interested or customers excited about their product. Numbers help tell the story by providing supporting details and credibility. Stories also serve as a reality check on numbers because they’re emotional while numbers are more logical and straightforward.
Baseball and other sports have long used storytelling to pick players, but now some teams are using statistics instead of scouting reports.
In sports, the use of statistics is called “Sabermetrics”. This approach swept the world of sports and has been used in many other areas. However, it’s more prevalent in financial markets where there are powerful tools that manipulate data. In these markets, investors can be overwhelmed by numbers and lose track of what they’re doing.
As the amount of information increases, people tend to make emotional decisions and they trust numbers less. They also look for simple stories that are easy to understand.
Theranos
A consumer health care technology company, Theranos, started by a 19-year-old Stanford dropout, promised to make blood tests cheaper and easier. The firm reached a $9 billion valuation.
Theranos was supposed to revolutionize the blood testing industry, but it didn’t work out. The Wall Street Journal reported that Theranos’ technology wasn’t accurate and its CEO may have lied about her credentials.
Storytelling and Your Valuation Model
Valuation experts and quantitative analysts share the same values. They use numbers to tell a story, but they can become better storytellers by following this five-step process:
Spin a story about the company. What are its growth prospects? Who are its managers and where is it in its life cycle? Apply the 3P test to your story: Is it possible, plausible, and probable? If you can make your business story credible, then you may have a winner.
Connect the story to the numbers. Support each part of your story with numbers, such as market potential and cash flows. You should also include other statistics that back up your narrative, like risk mitigation. Your story must align with the numbers; otherwise it won’t make sense to investors or others who want to know more about your business plan.
