The conglomerate’s earnings were real. They just arrived after the story did.
Most of us assume a stock price follows the business: earnings rise and the price rises, earnings fall and the price falls. George Soros noticed that the arrow also runs the other way, and one of his earliest cases was the conglomerate.
A conglomerate with a strong story trades at a high multiple of its earnings, and that expensive stock is a currency. The conglomerate can use it to buy companies with similar intrinsic value but weaker stories, trading at lower multiples, and the difference in multiples alone raises its earnings per share. The rising earnings confirm the story, which keeps the multiple high, which pays for the next acquisition.
Conglomerates had performed well because investors thought they’d perform well, which gave them a high valuation. The high valuation gave conglomerates the currency needed to acquire companies that had similar intrinsic values but were trading at lower earnings multiples.
So which came first, the earnings or the story? Soros’s answer is reflexivity: what investors believe about a company changes the company. Stock prices do not fall because earnings fall. Earnings fall because stock prices fall. When investors lose faith, the falling price cuts off cheap capital, which cuts off growth, which confirms the falling price.
The story delta
The conglomerate did not have to run its acquired businesses better than their old owners. The strong story literally manufactures earnings by absorbing weak stories. As long as the story delta is maintained, the company can succeed through this arbitrage. When the delta collapses, when the market stops believing the conglomerate is worth more than the sum of its parts, the whole mechanism reverses, and real operating earnings cannot stop the slide.
Why would the delta collapse? Girard’s account of bubbles gives one reason: the imitation that inflated the story produces a crisis once its inner workings become visible, and a bubble that can be seen as a bubble deflates fast. The collapse is also non-ergodic. Across all conglomerates, the average earnings growth looked excellent. For any single conglomerate, the path included the chance of total narrative collapse, an absorbing state from which that particular arbitrage cannot recover.
Capitalism runs on stories
The conglomerate is an extreme case of something ordinary. Capitalism builds a path to the future by letting future money pay for present-day work, and it creates wealth through asset valuation. Assets are, at bottom, stories about the future that people agree to treat as money today. A stock certificate is a story about future earnings, a bond a story about future repayment, a house price a story about future desirability. The stories range from harder ones with deep consensus and long history, such as gold and dollars, to softer ones with thinner consensus and shorter horizons, such as bank debt, bonds and equity. Counterparty risk rises as the story softens, because softer stories need more ongoing belief to sustain them.
This is not a weakness of capitalism but its mechanism. Capitalism does not build a bridge to the future, a single rigid structure that falls if one support fails. It builds a web of overlapping stories that can survive any one of them collapsing. The same loop runs through people. Picture a white American man whose father is CEO of a major corporation, who goes to Harvard and becomes a managing director at Goldman Sachs. He is successful and skilled, but much of that skill came from doors that opened because other people believed a story about his potential.
Both cases point the same way: there is no underlying value independent of the story. The conglomerate’s earnings were not fake, but they existed because the story existed first. The useful question about a story is less “is it true?” than “is it self-sustaining?”
Telling durable stories from hollow ones
That claim has a limit. Part of what a story props up can be measured. The asset value decomposition splits any price into intrinsic value plus imagination extrinsic plus liquidity extrinsic, so the story premium is the gap between what the cash flows justify and what the market pays. A story that holds for decades can create genuine, durable value, while one that collapses destroys value that was real while the story held. The line between the two is visible only in retrospect, which is why markets swing between euphoria and panic.
Statistics and other forms of grounding help break story addiction, the tendency to keep investing in a narrative long after the evidence has turned against it. But pure rationality is not the answer either, because stories create the reality that rationality measures. Telling self-sustaining stories from self-consuming ones is closer to art than to analysis, and the conglomerate’s shareholders learned which kind they held only when the delta closed.
References:
- Morgan Housel, The Greatest Story Ever Told, Collaborative Fund