I like watching NFL Football because of the strategy involved. This includes many variables of players, formations, and plays. Together, their goal is to move the ball to the 100 yard line. This is how they put points on the board. In some ways, value investing can be viewed as a simpler four step process, thanks to Warren Buffett. He said: “Charlie and I look for companies that have (1) a business we understand; (2) favorable long-term economics; (3) able and trustworthy management; and (4) a sensible price tag.”
Also read:
- Q2/H1 Hedge Fund Letters - Letters, Conferences, Calls, And More
- Hedge Fund of funds Business Keeps Dying Every Year
- Emerging Hedge Funds: Can They Outperform?
- Baupost Letter Points To Concern Over Risk Parity, Systematic Strategies During Crisis
- AI Hedge Fund Robots Beating Their Human Masters
Sports & Stocks by Bud Labitan
Understand that winning Football comes down to deciding on a run play, a pass play, or a kick. In Value Investing, I try to keep it simple by first trying to understand a business and its products and services. Second, I try to understand whether this business in front of me has something special. Is it special enough to win repeat customers? We want to see something so special that the business is hard to copy or replace. Thirdly, like Football, does it have able and trustworthy managers and coaches.
For a moment, imagine you are the ball carrier and decision maker. What should you do? Survey the field of businesses and look for profitable opportunities. Look for reliable businesses that have a history of producing extra cash in good times as well as economic bad times. We call this extra cash, FCF, Free Cash Flow. Like a receiver who is wide open, look for a business with minimal competition. Think of Debt as a bit of extra fat and weight on a swift runner. It slows us down. We want strong muscles and a practiced set of skills.
We all like to stay within our budgets. However, the sports industry is different from value investing when it comes to bargain seeking. Can the team, coach, players, or business be purchased at a reasonable price? This is difficult. Many sports teams are under pressure to produce winning teams every year. They are forced to pay premium prices when competing for a small number of great players. This is a reflection of the law of supply and demand. However, sometimes a strong team can be built by hiring a good combination of good players. An example of this is the Oakland Athletics Baseball team. The Oakland A’s reached the playoffs in four consecutive years from 2000 through 2003.
Moneyball: The Art of Winning an Unfair Game by Michael Lewis is a book (and movie) about the Oakland Athletics baseball team and its general manager Billy Beane. Beane and statistician Paul DePodesta used sabermetric principles to run the team in a cost-effective way.
Sabermetrics was pioneered by Bill James. It includes methods to collect and summarize data from in-game activity to answer specific questions. The term is derived from the acronym SABR, the Society for American Baseball Research, founded in 1971.
In 2002, the Athletics became the first team in the 100 plus years of American League baseball to win 20 consecutive games. Despite Oakland A's low revenue, the team’s analytical, evidence-based sabermetrics approach was used to assemble a winning low budget team. Other low payroll teams, such as the 2003 World Champion Florida Marlins and the 2008 American League Champion Tampa Bay Rays, have competed in the World Series.
Investing is competitive. Can we buy a high quality stock at a bargain price? First, make sure that our target stock is a piece of a high quality first-class business. In Value Investing we are not under the time and pricing pressure of sports teams. We have more time to evaluate our options. When these four investing filters are present, there is a higher probability of success.
One of my favorite quotes by Charlie Munger is very useful: "If you're going to be an investor, you're going to make some investments where you don't have all the experience you need. But if you keep trying to get a little better over time, you'll start to make investments that are virtually certain to have a good outcome. The keys are discipline, hard work and practice. It's like playing golf -- you have to work on it."
Golf? We can talk about golf later when discussing our mental game. Let’s get back to football for a moment and talk about defense. A good defensive strategy helps to prevent a loss. The role of the defense is to prevent the offense from scoring by tackling the ball carrier or by forcing turnovers (interceptions or fumbles). In investing, defense is acting to prevent the loss of your money. This is done by filtering out all the weak businesses.
We can filter out the weaker businesses by buying only the ones with great long-term economics. We want to invest in businesses that have something special, sometimes called a Moat. A Moat is the strong defensive water barrier that kings built around their castles. In investing, a Moat is a sustainable or enduring competitive advantage. Think Brands!
Next, buy only the stock of a business with able and trustworthy management. Some may be able. But, if they are not trustworthy, they will steal from you.
Here is another way Warren Buffett talks about his formula: “When buying companies or common stocks, we look for understandable first-class businesses, with enduring competitive advantages, accompanied by first class managements, available at a bargain price.” Look for those kinds of businesses.
In Football, the New England Patriots have won 5 Super Bowl Championships. They have done this with variations of good offense, defense, and special teams. They have also had great players, coaches, and management. Let’s also give credit to their enthusiastic fan base. In 1985, the Chicago Bears had such a team, and won that year’s Super Bowl. Interestingly, the team they defeated that year was the New England Patriots.
The special teams unit in Football is responsible for all kicking plays. The special teams unit of the team in control of the ball try and execute field goal (FG) attempts, punts and kickoffs, while the opposing team's unit will aim to block or return them. In investing, I think of the special teams as special situations like activist value investing.
In Activist Value Investing, an individual or group, purchases large numbers of a public company's shares and often tries to obtain seats on the company's board. Their goal is to cause a change in the company’s business. A company can become a target for activist investors if it is mismanaged, has excessive costs, or it could be run more profitably as a private company. The activist investors believe they can fix and make the company more valuable.
But, think, are they making the core business more valuable? This is riskier than the four filter steps I mentioned. However, sometimes their strategy works. So, you should be aware that this can sometimes work out well if the core business has good fundamentals.
In Investing, here is how Warren Buffett defines intrinsic value: “We define intrinsic value as the discounted value of the cash that can be taken out of a business during its remaining life. Anyone calculating intrinsic value necessarily comes up with a highly subjective figure that will change both as estimates of future cash flows are revised and as interest rates move. Despite its fuzziness, however, intrinsic value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.”
In Football, growth in skill, muscle, stamina, strength, and knowledge is important to success. In stock investing, most people think that business growth is important for a gain in intrinsic value and stock price. Yes, sometimes it is. But, growth is just one component in the calculation of value. A business does not always need to grow if it becomes more efficient and it generates more profit. Also, when a strong business buys back some of its stock, the remaining shareholders shares become more valuable. Why? Imagine a business that is equally owned by three sisters. When two of the sisters buy out the shares of the third sister, the business is now owned equally by the two remaining sisters.
What if those two sisters own a Football team. The Intrinsic Value of that team has not changed. However, the two remaining sisters now each own 50% rather than the 33% they had owned previously. So, their share has become more valuable. The “intrinsic value of their share” has become more valuable.
As a player in Football or Value Investing, you should think about good preparation and your inner mental coach. Are you motivated to learn the basics and keep learning along the way? Will you set a reasonable goal for yourself? Will you maintain focus on the most important variables? Are you thinking about proper self management? And, how will you deal with wins and losses? I talk about these ideas in later chapters.
What about players? The Chicago Bears did something interesting in this year’s NFL draft. They traded up to pick at the second spot. The Chicago Bears traded up to pick Mitch Trubisky, quarterback. An ESPN Analyst said in 2013: “Mitch Trubisky is a spread offense coach's dream when it comes to his combination of size, speed, savvy athleticism and arm strength. He is a shotgun passer who becomes more impressive the more you watch him.” As a fan of the Bears, I hope they use him wisely, and, that he performs well.
Like experienced wide receivers, you want to catch businesses with a record of performing well. You want guys or gals who have made the catch before. And, you want ones you can trust to continue running for yards after they make the catch.
Winning players and winning coaches must learn and grow their skills. My nephew Christian rightly pointed out that they should also work on growing and maintaining a winning attitude. I talk about this in the Mental Toughness chapter.
Just as you can learn to get comfortable scanning financial statements, great quarterbacks learn to read defensive formations better. Great running backs learn to read and time their runs towards profitable “gaps” they can run through. Great linemen learn their opponents tendencies. They learn to use proper timing and leverage to create those gaps for backs and receivers. As they become more experienced, players and coaches should also be able to develop new insights. They can also benefit from having the proper attitude. In investing, we can adopt the proper attitude too!
The great Paul William "Bear" Bryant was an American college football player and coach. He was best known as the winning head coach of the University of Alabama football team. During his 25-years as Alabama's head coach, he earned six national championships and thirteen conference championships. As we leave this chapter and move on to the next one, think about this great quote from the famous college coach Paul “Bear” Bryant: “Never quit. It is the easiest cop-out in the world. Set a goal and don’t quit until you attain it. When you do attain it, set another goal, and don’t quit until you reach it. Never quit.”
I end this chapter with a note to my daughter: “Never Quit Learning More” about the world around us. I have happy memories of the days when she played that other football called soccer. And, I have great respect for the players and fans of this global game.
Article by Bud Labitan
