As a value investor, Baupost Group head Seth Klarman (Trades, Portfolio) is no stranger to Benjamin Graham and David Dodd’s precepts. In an essay written as a preface to the sixth edition of Graham and Dodd’s "Security Analysis," Klarman compared value investors to the main characters of Michael Lewis’s 2003 book "Moneyball" (and the film of the same name).
Trust the numbers
"Moneyball" is about Billy Beane, the general manager of the Oakland Athletics in the early 2000s. Beane was one of the first sports executives to suggest that the conventional ways used to evaluate players were non-objective and flawed, and to instead use statistics like on-base percentage and slugging percentage.
Despite having a much smaller budget than baseball juggernauts like the Yankees and Red Sox, the A’s were able to use this team-building methodology to build a team that finished with a record of 103-59, and went on a 20-game winning streak. How did a small-market team with a tiny budget manage this? By exploiting inefficiencies in the market for players. Klarman explains the parallels between the A’s strategy and value investing:
“The market for baseball players, like the market for stocks and bonds, is inefficient - and for many of the same reasons. In both investing and baseball, there is no single way to ascertain value, no one metric that tells the whole story. In both, there are mountains of information and no broad consensus on how to assess it. Decision makers in both arenas mis-nterpret available data, misdirect their analyses, and reach inaccurate conclusions. In baseball, as in securities, many overpay because they fear standing apart from the crowd and being criticized.
They often make decisions for emotional, not rational, reasons. They become exuberant; they panic. Their orientation sometimes becomes overly short term. They fail to understand what is mean reverting and what isn’t. Baseball’s value investors, like financial market value investors, have achieved significant outperformance over time. While Graham and Dodd didn’t apply value principles to baseball, the applicability of their insights to the market for athletic talent attests to the universality and timelessness of this approach.”
One of Beane’s key innovations during his time with the A’s was to diminish the influence that scouts had on the player recruitment process. His thinking was that there was value to be found by signing players that didn’t necessarily pass the "eye test." Similarly, the best stock bargains are often found in boring industries, or in beaten-down companies that are going through a turnaround period.
The main lesson from "Moneyball," as Klarman alludes to, is that there are good profits to be found by being willing to go somewhere that other people are not. Being a contrarian is certainly not easy, but - as the A’s found out - it can pay off big.
Read more here:
- Deutsche Bank Posts Disappointing 3rd-Quarter Results
- Howard Marks: What Is the Difference Between Growth and Value Investing?
- What Effect Would a Warren Presidency Have on the Stock Market?
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