These Baseball Players Would Have Been Great Investors
These Baseball Players Would Have Been Great Investors
April is here and my thoughts turn to America’s pastime and the joy it brings. It’s also around this time that I remind myself about the obvious and intriguing parallels between investing and the greatest game ever played. They’re so informative and fun that I often make use of them when educating my clients on market principals. For instance:
· Baseball is black and white. At the end of the game someone wins and someone loses. Investing is similar. While passive investors generally capture their fair share of the market’s growth, active investing is a “zero-sum” game. In any given trade, the seller believes the stock is overpriced, and the buyer believes it is underpriced. They can’t both be right and, to the extent that one of them is (at least in the short term), the winner’s gain will mirror, exactly, the loser’s lost opportunity. There is no tie.
· The value of an individual player or team can easily be proved or disproved with quantitative data. This is especially true in Baseball, where (unlike other sports) a player’s value is well represented by quantitative data. In investing, the amount of money made is likely the only thing that matters.
· The baseball season is 162 games long. Players may suffer short-term slumps but, in the end, the data is normalized. Investing is a marathon. Judging investments or investors on short-term data is often a poor choice. In some cases, a company’s stock may be trading at a large premium or discount to its true value however, in the long run, the market is priced right.
· Even if Kershaw is on the mound, games aren’t won by a single individual. An offense needs guys who get on base and guys who drive them in. Successful investing is rarely the result of one company but rather a portfolio of companies. In many cases, proper diversification results in synergies that increase the amount of reward per unit of risk.
· Both are intellectually stimulating to follow. I’m an avid fantasy baseball player and professional value investor, always looking for undervalued players and undervalued stocks.
The similarities between Baseball and investing have been documented before, most notably by best selling author Michael Lewis (who not coincidentally has written a great deal about Wall Street as well). His book “Moneyball” describes a term of the same name given to Oakland A’s general manager Billy Beane’s use of a new generation of statistical measures, or metrics, to build a competitive advantage over teams with higher payrolls.
If you aren’t a baseball fan, the Oakland Athletics, for most of their history, have operated at a severe disadvantage compared to their American League rivals like the Yankees and the Red Sox. Their total team payroll is often a fraction of those teams. And, for years, their performance lagged behind as well.
All that changed in 1997 when Billy Beane took over as the team’s General Manager. Essentially, he took a disadvantage and turned it into an advantage. He couldn’t afford the expensive free agents the Yankees and Red Sox were always fighting over, so he got smarter. He learned to underpay for underrated players rather than overpay for all stars.
Beane took the value principals that Bill Graham and Warren Buffet preach and applied them to baseball. He searched areas of the market that other managers ignored and used quantitative data to calculate the intrinsic value of a player or a company. He focused on finding underrated players, whose value wasn’t completely understood by other managers.
Beane leveraged the life work of Bill James, a baseball analyst who made a compelling case that too much attention was paid to stats like batting average and runs-batted-in (RBIs), and not enough to lesser-known stats like on-base percentage and slugging percentage. If a player got on base more often than another player with a higher batting average simply because he was more patient and drew more walks that, in the long run, would contribute more to winning. So Beane stacked his line-up with players with a slightly higher on-base percentage and, over the course of a long season, that small advantage compounded and translated into a poorer team significantly outperforming many teams with higher payrolls.
Like any investment strategy, the Moneyball approach didn’t guarantee Beane immediate success. While Oakland put together that memorable 20-game win streak, the normal 162 game season was critical for his strategy to truly pan out. This is similar to investing, when short-term results rarely prove an investment strategy successful. For instance, in 1999, Warren Buffett characterized the risk mood of the hot bull market as one of “unsupportable optimism.” In December of that year, Forbes even ran an opinion piece entitled “Buffett: What Went Wrong?”, criticizing him for being slow to jump on the high-tech bandwagon. But, when the bubble burst the following March, Buffett had the last laugh.
Similar to Buffett and other value investors, Beane trusted that decisions would pan out in the long-run and did his best to keep emotions at bay. Similar to how Buffett doesn’t follow daily market fluctuations (noise), Beane would rarely watch games live because he didn’t want to make an emotional decision.
It’s no secret Beane will one day go down as one of the greatest to ever coach, but I wouldn’t feel right discussing the similarities between investing and baseball without mentioning my favorite old-time player, Yogi Berra. If you aren’t familiar with Berra, he is a Hall of Fame catcher who formerly played for the New York Yankees.
Berra was selected to play in many All-Star Games and was awarded MVP three times. He helped the NY Yankees win the world series 10 times in his career.
Yogi (perfectly) displayed many of the traits of a successful investor.
Yogi was consistent. He had no poor performing categories so he didn’t have to lead any either. He led catchers in number of games played for a good portion of his career and he rarely struck out. While he was a good offensive player, it was his defense that truly made him remarkable. Yogi was Consistent and didn’t make many mistakes. These two attributes characterized Yogi’s career and, also, the career for many superior investors.
Although Yogi was one of the all-time greats, his baseball achievements may be overshadowed by some of the things he has said, now called “yogism’s, including:
• No one ever goes to that restaurant anymore, it’s too crowded: Going against the grain is a crucial trait for investors. It’s rare that a ‘hot’ stock will turn out to be a good investment.
· The future ain’t what it used to be: While the future may rhyme with the past, it won’t be the same.
• You can observe a lot by just watching: Sometimes, it’s just as simple as looking! This was true for the few folks that predicted the most recent real estate bubble and the subsequent market collapse.
“Baseball is ninety percent mental and the other half is physical” was another phrase Berra made famous, and I think it’s highly useful for investors. Ninety percent of the effort to beat the market may consist of good due diligence but investors need to put more energy into understanding human behavior. Because, after all, market prices are a collective result of the thoughts and behaviors of millions of underlying investors.
But Berra’s method wasn’t the only way to excel. Reggie Jackson (nicknamed Mr. October because of his ability to come through in the clutch) was a completely different type of player? Jackson is one of the greatest home run hitters of all time but he also holds the record for the most career strikeouts (he struck out 4x the amount as Berra). He’s a hall of famer and a player who is likely to be in the discussion of the greatest players to ever play the game.
But most individuals aren’t blessed with the raw power of Reggie Jackson and most investors don’t have access to invest in the next Facebook on the private market. Therefore, I’m a proponent of value investing as I think it is the best way individual investors can minimize downside risk and earn superior returns in the long-run.
In previous articles, I’ve mentioned how value investors believe that, while it isn’t possible to time the market with any precision, it does make sense to take the overall temperature of the market—particularly its risk mood and how that mood might impact our portfolio. When optimism and certainty dominate investor sentiment, and people are more afraid of missing out on potential profits than of possible losses, contrarian investors smell an overheated market. They pull back and adopt a more defensive investing position: protecting themselves from irrational exuberance, and from a possible bubble getting ready to burst.
This is defensive investing, which is synonymous with value investing and important for individual investors. Defensive investing involves several different strategies. One is simply exercising restraint: refusing to jump on the hot trend of the moment.
Playing defense usually involves shifting some of your asset allocation away from equities for a greater emphasis on cash and cash equivalents, and on fixed-income securities. It can also involve moving the equity portion of your asset allocation toward so-called “blue chip” stocks: older, established companies like IBM and Wal-Mart, that yield steady if modest returns and often pay regular dividends. Such companies tend to weather the storm of a downturn better than other companies, and also tend to rebound more quickly from recessions.
The tricky part about playing defense is that it’s impossible to time with any precision. Even George Soros failed to move out of technology stocks before the bubble burst and paid the price. In the last chapter, I offered a few metrics that indicate the market is probably overvalued, and may be headed toward a bubble. Yet prices can be high and yet continue to rise for some time, the 1990s bull market being a perfect case in point. Although Buffett declared the market overvalued in 1997, the bull market raged for another two years. (Others called the market overvalued as early as 1992!) As individual investors, you don’t need perfect timing to make profitable escape from overvalued markets because high prices eventually revert.
In investing, as in sports, good defense often translates directly into good offense. Offense in investing is the freedom and the courage to jump into a depressed market and take advantage of low prices and good values precisely during those times when investor sentiment is fearful and people are more likely to be selling than buying. Yet you can’t take advantage of such bargains if you haven’t first shifted some of your money away from stocks and toward more liquid assets like cash, money market funds, and short-term Treasuries. This provides you with what professional investors call dry powder: discretionary funds that can quickly be targeted toward attractive buying opportunities.
Many investors are too slow to play defense and too slow to shift from defense to offense. In 1968, Warren Buffett was getting ready to pull out of the market at the time 35% of private U.S. investment was in equities. Investors shifted away from stocks during the stagnant 70s, but then were slow to jump on the ensuing bull market. As late as 1989, a full seven years into the bull market, only 13% of private investment was in equities.
Yogi-like Patience is the common denominator of contrarian investing in both good times and bad. Patience allows you to pull back in an overheated market and continue to show restraint, even while conventional wisdom urges you to buy. And patience enables you to stick with a value stock bought at a bargain price, even in the midst of a panic, and even if it takes the stock years to bounce back.
Patience is also, often, the move you don’t make. Successful investing requires inactivity just as successful batting requires taking pitches. It’s smart to think of investing as stepping up to the plate in baseball. Each pitch we see is a potential purchase. Some are strikes and some are balls; yet, unlike a hitter in baseball, it is difficult for investors to strike out by merely looking.
Even though you can strike out in baseball, two of the greatest hitters in the game’s history, Babe Ruth and Ted Williams, were legendary for their patience. For every home run that he hit, Williams watched 30 balls go by. In fact Warren Buffett closely read Williams’s book The Science of Hitting and has made frequent use of it in his investing. The legendary hitter describes how he mentally broke up the strike zone into 77 “cells,” each the size of a baseball. Three and a half of those cells represented his “sweet spot”—the pitches he knew he could hit, and hit hard. He felt his success as a hitter was largely due to discipline and patience: letting pitches in the other 73 ½ cells go by, and waiting for the handful in his sweet spot.
Some other players who would probably have been great investors are:
Ricky Henderson: Led the league in ”non-sexy” stats such as walks and stolen bases.
Hank Aaron: The greatest player in history had one of the longest careers.
Willie Mays: Never broke a single record, but was consistent and a great defensive player.
Eddie Murray: As consistent as they come having drove in 75 plus runs for 20 consecutive seasons.
Cal Ripkin Jr: 2,632 consecutive games, PERIOD!
As the 2017 season is upon us (The Mets are 1- and MadBum is leading the NL with 2 HR), I’m sure the topic of baseball won’t go away anytime soon. Stay Tuned!