Today’s Take: Know the difference between value and storytelling.

Tokyo’s Imperial Palace was once worth more than all the real estate in California.

In 1989, Tokyo real estate sold for as much as $139,000 per square foot — 350 times the value in Manhattan at the time.

Back then, investors believed Japan was the economy that would take over the world.

U.S. mutual funds attracted boatloads of investors’ money to invest in Japan. And the Nikkei 225 Index soared to nearly 40,000.

No price was too high for Japanese companies. But then … fundamentals started to matter.

Just like trees can’t grow to the sky, stocks can’t go up indefinitely.

The Nikkei 225 began a long, 30-year decline. It now stands 25% lower than it did in 1989.

Back then, I didn’t invest a single nickel of my clients’ money in Japan.

I didn’t have a crystal ball that told me how long and sharp the decline would be.

But I avoided Japan because I knew the difference between storytelling and true value…

Price = Value + Storytelling

A stock’s price can really be broken down into the fundamentals — or the value of the business — and what I call “storytelling.”

For example, let’s say a company’s stock is trading for $20 per share.

If I estimate the underlying worth of the business to be about $15 per share, then the remaining $5 is from the story…

It’s the extra price that Wall Street is placing on a bright future, excitement about a new industry or trader euphoria.

And during bull markets — where investors believe the world is perfect and the future is worth any price — the storytelling part of the stock price can reach amazing heights!

In fact, the value part of the stock price can sometimes be nonexistent. A stock price could be 100% storytelling.

And that was what was happening in the late 1980s with Japanese stocks. From my seat, prices seemed to be 95% storytelling and only 5% value — at best. That’s why I didn’t invest.

Because following only a story can be one of the most dangerous things you can do as an investor…

Buy When Storytelling Is Near Zero

Investors will pay high prices solely based on a hope or dream that the business will grow, stop losing money or get over whatever hump it’s stuck behind.

But you never want to pay for a utopian future.

I wanted to share these thoughts with you now, while the sun is shining and the stock market is making new highs almost every day.

Because I’m not trying to predict when, but the party will stop at some point. And when it does, fundamentals will matter — just like it did for Japanese stocks.

And I want you to be able to sleep well at night without worrying about your portfolio or losing everything when the selling starts.

That’s why I always recommend you buy stocks when the storytelling part of the price is close to $0 and the underlying value of the business is worth more than its current stock price.

It’s like shooting fish in a barrel with all the water drained out. That’s the way you make real money in the stock market.

Charles Mizrahi

Charles Mizrahi

Founder, Alpha Investor