13 August 2013
Moneyball, the book and the movie, contain all sorts of important lessons and both have struck a chord with its audience and have both been positively received but outside of the investment world I would imagine most watchers of the movie have no idea how well it represents what money managers like myself try to accomplish in our search for investment opportunities.
The focus of the story is how the Oakland A’s managed to win 91 games in 2000 and 102 games in 2001 while only spending $26 million for 27 players in 2000 and $34 million for 28 players in 2001. The Yankees in comparison won 87 games in 2000 and 95 in 2001 while paying $85.1 million on 26 player salaries 2000 and $116.3 million for 29 players in 2001 (Information sourced by baseball-almanac.com). Another way to look at this data is that Oakland paid $285, 714 per win in 2000 while the Yankees spent $978,160. It wouldn’t take a value investor much longer than a few seconds to determine who created more value. Mr. Lewis echoed this on p. 288 “…some baseball executives seemed to be much better than others at getting wins out of dollars.”
Value investors also look for opportunities in the market where value and price have diverged. This was just what Billy Beane and the A’s where doing as explained by Mr. Lewis in the book preface:
“…set about looking for inefficiencies in the game. In what amounted to a systematic scientific investigation of their sport, the Oakland front office has reexamined everything from the market price of foot speed to the inherent difference between the average major league player and the superior Triple-A one. That’s how they found their bargains.”
While we conduct the same process in investing luckily there are many more companies than teams in MLB so in most periods, if you dig long enough, you will find a company that is misunderstood in the market. This one element, the misunderstanding or misjudgment of talent and companies, is vitally important to any successful baseball general manager and investor.
Another lesson gleaned from Moneyball is that it takes a combination of looking at the raw numbers (stats in baseball, quantitative analysis in investing) and evaluating the rest of the picture. The perfect illustration of this in the book is when Paul DePodesta is examining player stats and discovered a player, David Beck, while looking over a pitcher who was a consensus first round draft pick. Paul looked over the others pitchers on that team and discovered that Beck actually had better stats then the consensus first round pick. Paul asked the scouts to look at him and the scouts eventually told him that the pitcher was a “soft tosser”, scout code for someone not worth looking at. Later the situation changed and the head of scouting decided to draft the player without ever having seen him throw a pitch.
The reason Beck had been undrafted soon became apparent when they saw him pitch. They saw “…one of the most bizarre sights any of them had ever seen on a pitcher’s mound. When the kid drew back his left arm to throw, his left hand flopped and twirled maniacally…” All the other scouts had ignored Beck because he didn’t pitch the way everyone else did, he was different. A parallel in the investing world was when investors bailed out of Warren Buffett’s company, Berkshire Hathaway, during the internet bubble because he wouldn’t invest when everyone one was investing in overpriced technology stocks and making “easy money”.
What’s interesting is that David Beck ended up not making it to the big leagues. In this case it seems the numbers alone didn’t tell the whole story. It’s like finding a company with great fundamental numbers lead by a management team that has horrible capital allocation skills. To be really successful you have to find a player or company that has the complete package.
In the following section I highlight several sections that contain important lessons and talk about how they are also relevant to the investing world.
Quote 1: “..the point is not to have the highest on-base percentage, but to win games as cheaply as possible. And the way to win games cheaply is to buy the qualities in a baseball player that the market undervalues, and sell the ones that the market overvalues.”
Investing Lesson: One of the most basic lessons in investing. You must buy when others are selling. This sounds obvious and easy but when these opportunities become available the company will likely be facing a difficult short-term situation. You will also be hard pressed to find anyone positive about the company (or the market in certain situations) and most people find it had to align themselves against the consensus view of any given particular situation.
Quote 2: “For Billy and Paul, and, to a slightly lesser extent, Erik and Chris, a young player is not what he looks like, or what he might become, but what he has done.” (p. 38)
Investing Lesson: An investor should examine a company’s past performance and use it as a guide to the quality of the business first and then form their own impressions of the quality of the company’s future franchise. This is not a hard and fast rule for companies as occasionally one that hasn’t performed well historically can turn the corner under a new management team or one that discovered the flaws in their business model. One such company is Verisign. The company came to understand its acquisition strategy had failed to create long-term value and changed course by selling them off, reinvesting back in their core business, paying special dividends, and buying back stock.
Quote 3: The book is talking about the oldest scout in the room named Boogie. He had been sent to scout Billy Beane and said “Billy was a guy you could dream on.” (p.42)
Investing Lesson: You shouldn’t make a stock purchase based solely on high expectations or because the company, while currently not profitable, is projected to have incredible growth, margins and future prospects. You have to form reasonable expectations and only make an investment when the price of the security and your expectations meet. You conclusions may not be the same view that is held by the “street” but don’t let that deter you.
Quote 4: Paul DePodesta, “You know what gets me excited about a guy? I get excited about a guy when he has something about him that causes everyone else to overlook him and I know that it is something that does not matter.” (p. 116)
Investing Lesson: The best investments usually are found in areas where others don’t understand the value equation or are overweighting an negative issue the company is dealing with. Reis is one company that comes to mind that found itself mired in just such a situation. The company had two divisions, one had been performing very well and the other was in run-off mode but had an outstanding liability present in the form of a lawsuit. Even after the lawsuit was settled there was a period of time where the situation still was not widely understood and thus the stock remained undervalued.
Quote 5: Paul DePodesta. He and Michael Lewis are in the film room watching the New York Yankees take it to the A’s. Michael is getting fired up because the A’s are not playing well and the Yankees have been taking advantage of that with a good deal of success and nobody else in the film room is showing any reaction. Paul says “It’s looking at process rather than outcomes. Too many people make decisions based on outcomes rather than process. It’s not what happened it’s how our guy approached it.” (p. 146)
Investing Lesson: You will not be right about every investment you make. The key is to do the develop a process that includes conducting a thorough review of the company, purchase it an price far enough below your estimate of its intrinsic value that you have a margin of safety and have the discipline and patience to wait until others also recognize the value. If you finally conclude your have made a mistake don’t stall on making the sale, do it and figure out what went wrong in your decision process.
Quote 6: Scott Hatteberg is in the film room reviewing tape of a pitcher he has not had much luck hitting against. “…Hatteberg considers why everyone doesn’t prepare for Jamie Moyer as he does – by watching tape, imagining what will happen, deciding what to look for, deciding what he will never swing at.” (page 184)
Investing Lesson: This is another example of the disciplined process and persistence it takes to succeed in any realm of study. Scott had developed a process that helped him prepare for possible situations that he could excel at and also to see what situations he should avoid. The search discipline is the same for investing. You must understand what companies fit into your circle of competence and avoid those that are not understandable or are currently overpriced. As an investor you should always be looking for companies that fall into your circle of competence, even if they are currently overvalued, so you can watch them in case the situation changes. You should also develop an understanding of situations to avoid. Investing in IPOs is one such situation that in the vast majority of cases should be avoided. IPOs tend to be of companies that are hot in the market right now and in most cases will be sold at a premium valuation.
Quote 7: Mr. Lewis listed 5 rules used by Billy Beane when he is shopping for players. The first doesn’t apply to investors but the last 4 are good rules to follow (p. 193-194):
“The day you say you have to do something, you’re screwed. Because you are going to make a bad deal. You can always recover from the player you don’t sign. You may never recover from the player you signed at the wrong price.”
“Know exactly what every player in baseball is worth to you. You can put a dollar figure on it.”
“Know exactly who you want and go after him.”
” Every deal you do will be publicly scrutinized by subjective opinion. To do this well, you have to ignore the newspapers.”
Investing Lesson: I think these five rules sum up the lessons from the book quite well. Price, i.e. valuation, is all important in investing just as in baseball. When you find the right company selling at the right price you need to invest a meaningful portion of your portfolio in that company. You must be able to stay investing based on your own reasoning and be able to ignore the opinions of the crowd.