A story stock is the stock of a company that trades at prices based on a story surrounding it rather than on the company's fundamentals. Story stocks are usually considered tremendously overvalued by a majority of finance professionals. Story stock companies tend to leverage their status as public companies to access capital and sometimes forecast earnings growth rates that exaggerate their strength.
Investors in story stocks heavily weight the potential for future earnings in their decisions to buy. Story stock companies have potential, at least in theory, if not strong current cash flows or substantial assets.
While you should be cautious if you decide to invest in a story stock, it's possible to significantly profit from doing so. Conservative investors may dismiss the value of a stock by calling it a story stock, but more aggressive investors can opt to buy high-quality story stocks as growth stock opportunities. Keep in mind that, when you buy a stock based on a story, anything that hurts that story is liable to cause a steep decline in the price of the stock. The value of a story stock can rapidly drop by 30% just by missing a revenue target by 1%.
Story stock examples
Here are a few examples of classic story stocks. Notice that some of these companies have created immense value for shareholders -- sometimes the story turns out to be true!
1. Amazon
Amazon's (AMZN +0.23%) story was that it would take over the online retail market. The company confounded traditional value investors for years because it would lose money and discount its products even more, but the stock's price essentially never went down. The company's price-to-earnings (P/E) ratio over the past 10 years has consistently remained over 80. Amazon did take over the online retail market and is the most successful story stock of all time.
2. Tesla
The story of Tesla (TSLA -0.30%) is that of the first luxury electric car maker, with a charismatic CEO, Elon Musk, and predictions that Tesla would become the 800-pound gorilla in the burgeoning electric vehicle market. The company's enterprise value has exceeded $2 billion for the past 10 years despite not becoming profitable on an annual basis until 2020. Tesla's P/E ratio at the end of 2020 was an astronomic 1,342.
Whether everyone will drive an electric vehicle and Tesla will dominate the industry is still undecided. Regardless of the company's future prospects, its stock clearly trades with significant growth potential already priced in.
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