When Stock Stories Are Fairy Tales

— -- Like many investors, you may own shares that you bought at least in part because you liked what you’d heard about the company. This could be because the company had been the subject of a high level of media coverage. These are known as "story stocks" simply because they’re the subject of many stories based on the interesting concept underlying the enterprise.

To some extent, these shares trade on their renown, and often, this renown develops or gains momentum from famous and charismatic executives who have captured the fancy of the media. Sure, it helps to have market-leading products and sound financials, but nothing advances a company like heavy infusions of capital from stock purchases driven by public attitudes that sometimes approach idolatry.

Examples of story-stock companies include:

Tesla Motors, the manufacturer of sleek, all-electric vehicles, gets a boost from bountiful media coverage and a media obsession with the company’s co-founder, CEO and product architect, Elon Musk. He recently made news by announcing that his private space exploration company, SpaceX, is planning to put humans on Mars within six years.

Berkshire Hathaway, the investment company headed by the legendary Warren Buffett, perhaps the most widely quoted and imitated professional investor on the planet. To the extent that Berkshire Hathaway relies on Buffett to sustain its story, that sustenance will probably dwindle in the coming years, as new blood takes over. Already, these investor successors are making moves markedly different from classic "Buffetteering."

Apple, which dominates the business news with its constant iPhone iterations and which gained renown because of the public's fascination with the innovative brilliance of the late Steve Jobs. Though Jobs died in 2011, the legacy of his genius continues to feed the Apple story.

Where many individual investors go wrong with story stocks is rooting their purchases of them in what behavioral finance experts call familiarity bias. That’s when people are more inclined to invest in a company because they know something about it. The allure of familiarity is rooted in investors’ confusion of knowledge about a company with its prospects for growth. They often aren’t considering the companies with which they’re unfamiliar, though these lesser-known stocks might render far greater returns.

Often, the story surrounding story stocks is that they are disruptors -- challengers to the status quo in their industry. But sometimes investing in disruptors can be disruptive to your wealth accumulation. An example is Conseco, an insurance/finance conglomerate that became one of the biggest bankruptcies ever in 2002. This was a story stock that generated buzz from touting magic managerial bullets to failing insurance companies and making them suddenly efficient. Co-founder and CEO Steven Hilbert, who was paid $172 million as he built Conseco but wound up owing more than $160 million to it when he left, had been surrounded by the cult of personality, driving this story stock. The company ended up greatly diminished after being forced to sell its finance business.

Other disruptors may do better, but many, only for a short time. If they have sustainably competitive innovations, they may get out front and stay there. But more often than not, their short-term success prompts also-rans to enter the market, and the competition marginalizes their success. This is what happened to GoPro. Initially a company with great sales and buzz, GoPro has had three consecutive declining quarters as the novelty of head-mounted cameras has worn off and competitors have entered the market. CEO Nick Woodman is the "action figure" for this action product, himself the subject of many news stories and publicity from “Shark Tank” appearances. GoPro’s fortunes show that a charismatic leader can only take a story stock so far.

Sometimes the entire sector is a story. Think tech stocks in the 1990s — one of the most inflated and irrational bubbles the market has ever seen. Companies with no profits and high expenses were going public. Of course, the air came whizzing out of this bubble in 2000. The poster child of the promise of growth was pets.com, an online pet food and pet care product retailer. The company lasted about a year. The more product it sold, the more money it lost.

Currently, the green energy sector could easily qualify as assemblage of story stocks. People concerned about the environment buy into them, undaunted by or unaware of their sometimes poor fundamentals and the countering realities of the thriving fundamentals of coal, oil and natural gas — the last two being produced in increasing abundance here in the U.S. through shale and oil sands mining.

If the sector showed promise of increasing its contribution to domestic energy usage from 1 percent to, say, 5 percent, green energy’s real story would be entirely different. But middle-age people interested in good returns in their lifetimes probably shouldn’t make anything greater than a small long-term bet on green energy as a gesture toward socially responsible investing.

The fundamental problem with story stocks is their prices are typically bid up by investors who have gone ga-ga over the story. As a result, they often trade much higher than they should relative to their profits, given the financial fundamentals of these companies.

Except for dips where opportunistic investors can dive in, story stocks tend to be priced up. Buying high-priced stocks really isn’t my cup of tea because I like to make money. I tend to be more of a contrarian investor, seeking to buy value stocks—those that show signs of being under-valued rather than over-valued, and thus have more potential to rise substantially. The opportunities to do so with story stocks are rare. Thus, to value investors, stock stocks are like Kryptonite to Superman.

For every Apple and Berkshire, which have pumped out dependable and even spectacular earnings over many years, there’s probably 100 buzzed-about wannabes and flops.

Yet depending on when you buy and when you sell, story-stock investing can make sense. But if you don’t want to jostle your portfolio very often, then investing in story stocks for the long haul may mean buying high and not seeing much share price growth.

The key is to approach story stocks like any other – with great skepticism. Be a doubting Thomas, and make the stock prove itself to you. If the story helps get you returns, fine. But be alert for signs of weakness so you can get out in time if the story that priced it up before you bought starts to wear thin.

Above all, remember: If you’re at a party and you hear about a stock’s great story, and the narrator of this story has a gleam in his or her eye, then many people are latching on to the story, and the stock is usually priced up. That advice also holds doubly true for companies promoted by media pundits who can’t resist a good story.

Editor's note: Any opinions expressed in this column are solely those of the author and are not investment recommendations. Disclosure: the author does own shares of Apple. Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry.