Value Investing

Steven Crist On Value

Steven Crist On Value

by Steven Crist

A typical liberal-arts education sets a graduate loose upon the world with a tremendous amount of knowledge he will never need or use again and some gaping holes about how actually to function in society. He may know the abbreviations for the periodic table of elements and the names of the leading Renaissance poets, but have no idea how to make a cup of coffee or write a business letter.

H/T Barry Ritholtz

A similar situation exists for the American horseplayer, self-taught through handicapping literature and days of hard knocks at the old horse park. He has vast amounts of handicapping data swimming through his head-names, dates, running lines, speed figures, pedigrees, trainer patterns and angles-all devoted to the goal of discovering the likeliest winners of horse races. When it comes time to go to the betting windows, however, nearly every one of these well-informed enthusiasts almost immediately surrenders his edge. He is like the chemistry scholar who knows the molecular structure of the coffee bean but has no idea how much water to put into the percolator. Each is unable to convert his knowledge into something useful and pleasurable-a steaming cup of java, or a consistent profit on racetrack bets.

Steven Crist On Value
Source: Pixabay
Steven Crist On Value

This is not to suggest that universities should stop teaching chemistry or literature, or that horseplayers should not continue to develop and enhance their skills as selectors. Like a liberal-arts education, the study of horses and how they perform is a worthy pleasure in itself, and in the case of handicapping, the world’s savviest bettor cannot win with bad opinions. The point is that pure handicapping is only the first half of the battle in winning at the races.

Most horseplayers intuitively know this, but don’t do much about it except complain. How often have you or a fellow trackgoer opined that you’re a pretty good handicapper but you really need to work on your betting strategies or your so-called money management? This is sometimes an exercise in denial for people who are in fact bad handicappers, but it is probably true for many who can select winners as well as anyone.

The problem with this line of thinking is that it suggests betting is some small component of the game, which is like pretending that putting is a minor part of championship golf. In fact, if you handicap well and bet poorly, you’ve failed. It’s as useless as crushing your tee shots while three-putting every green.

Turning your enthusiasm for racing and proficiency at handicapping into profitable betting requires an entirely new way of thinking about playing the races. It would take a far longer treatise than this chapter to explore fully the mathematics and mechanics of racetrack betting, and the strategies available to optimize one’s wagering through different types of bets. Instead, the purpose here is to raise three fundamental concepts that may help the serious handicapper to focus on profit rather than prediction, making money instead of just picking winners: probability and odds; handicapping the competition; and using multiple bets to improve your prices.

Probability and Odds

Forget for a moment everything you know about parimutuel betting and pretend that horse racing is set up like sports betting or a game of blackjack: If you pick the winning horse, the track doubles your bet. Every winner, regardless of how many people bet on him, pays $4.

Now ask yourself two questions:

  1. Do you want to play?
  2. How would you handicap and bet differently from the way you do now?

Most horseplayers will realize after a moment of thought that the correct answer to the first question is yes. It might not be a great deal of fun, but you could sit around and wait for mismatches, races in which one horse is so clearly superior to the competition that anyone could fairly agree that he has a better than 50 percent chance of winning the race. You would never bet a horse you honestly believed had less than a 50 percent chance of winning.

If you could find 50 races in which you discovered a horse with a legitimate 70 percent chance of winning, you would invest $100-50 $2 bets-and get a $4 payoff on 35 of those 50 races for a return of $140. A $140 return on a $100 investment is a 40 percent profit, and you could quit your day job and spend the rest of your life refining your criteria for horses with a 70 percent chance of winning.

Racing unfortunately does not work this way. Horses that everyone perceives as having a 70 percent chance of winning pay substantially less than $4 because the odds are determined by the amount of money actually bet on each horse, and because track takeout and breakage further depress the payout.

It’s worth examining the mechanics of this situation. Let’s look at a $1,000 win pool on a hypothetical four-horse race in which every contestant attracts an amount of betting that accurately reflects his chance of winning:

Steven Crist On Value

Now, what will these horses actually pay to win? Based on the percentages, most horseplayers would guess about 1-1 ($4), 5-2 ($7), 6-1 ($14), and 20-1 ($42). In fact, the payouts are significantly lower.

Let’s say this race is being run in Kentucky, with a 16 percent takeout and breakage that rounds payoffs down to the nearest 20-cent increment. That leaves only $840 of the original $1,000 pool to split up among the winning ticket-holders. (The other $160 goes to pay the race purses, maintain the track, and fatten the coffers of the Bluegrass State.) So Horse A does not pay $4, but $3.36, which is rounded down to $3.20. Horse B does not pay $7, but $5.60. Horse C returns $11.20 instead of $14, and the longshot returns $33.60 instead of $42.

In each of these cases, the actual return is lower than what is required to break even, much less show a profit, over time. If you bet horses who win 50 percent of the time and pay $3.20, you will lose 20 percent of your investment.

The point of this exercise is to illustrate that even a horse with a very high likelihood of winning can be either a very good or a very bad bet, and the difference between the two is determined by only one thing: the odds. A horseplayer cannot remind himself of this simple truth too often, and it can be reduced to the following equation:

Value = Probability x Price

This equation applies to every type of horse and bet you will ever make. A horse with a 50 percent probability of victory is a good bet at better than even money (also known as an overlay) and a bad bet at less (a.k.a. an underlay). A 10-1 shot to whom you take a fancy is a wonderful overlay if he has a 15 percent chance of victory and a horrendous underlay if his true chance is only 5 percent. There are winning $50 exacta payoffs that are generous gifts and $50 exacta payouts where you made a terrible bet.

Now ask yourself honestly: Do you really think this way when you’re handicapping? Or do you find horses you “like” and hope for the best on price? Most honest players will admit they follow the latter path.

This is the way we all have been conditioned to think: Find the winner, then bet. Know your horses and the money will take care of itself. Stare at the past performances long enough and the winner will jump off the page.

The problem is that we’re asking the wrong question. The issue is not which horse in the race is the most likely winner, but which horse or horses are offering odds that exceed their actual chances of victory.

This may sound elementary, and many players may think they are following this principle, but few actually do. Under this mindset, everything but the odds fades from view. There is no such thing as “liking” a horse to win a race, only an attractive discrepancy between his chances and his price. It is not enough to lose enthusiasm when the horse you liked is odds-on or to get excited if his price drifts up. You must have a clear sense of what price every horse should be, and be prepared to discard your plans and seize new opportunities depending solely on the tote board.

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