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The Stock Market's Box Score: Part II


...the most overrated question in the country is, "How'd the market do?"


Click here to read The Market's Box Score: Part I

"People operate with beliefs and biases. To the extent you can eliminate and replace them with data, you gain clear advantage."

"Whom the Gods wish to destroy they first call promising."
Source: Moneyball, Michael Lewis

The Book:

There were several little examples of scouts for baseball teams looking at the wrong things because of their inability to trade their subjectivity, based on years of "understanding baseball" with the objectivity that clear thinking, better data, and an open mind could have afforded them. For example, Bill James, who is regarded as the godfather of baseball statistics, proved in the 1980's with compelling evidence that the Southern United States was "over-scouted" but that the Great Lakes Region was "under-scouted."

One of the not-so-little examples of bias from the book and what rolled together Beane's approach the very best, was documented in a heated discussion on draft day. Below are a couple of cuts from that conversation where even Beane's own scouts were blinded by what they saw, instead of relying on their own homework and disciplines. None of the scouts had one particular catcher ranked in their top thousand or two thousand prospects, yet incredibly to them, Beane wanted to draft him in the very first round.

Scout: "He is a bad body catcher."
Beane: "A bad body who owns the Alabama record books."
Scout: "When he walks his thighs stick together…put him in corduroys he'd start a fire."
Beane: "We are not selling jeans here."
Scout: "He can't run."
Beane: "He's leading the country in walks."

They drafted him. Not only because Beane thought he was better than other teams believed, but due to that conventional wisdom he could underpay. To sign him to a contract, the Oakland A's did not have to agree to traditional first round prices. They wanted a better player, and they wanted to underpay.

The Market's Translation:

When it comes to stock prices, we are focused on the same combination of better analysis along with the selectivity of only agreeing to prices when they are favorable to us. We need to be patient enough to wait for our price on the way in, but just as willing to part with those same shares however dear they may seem, if we are offered prices even more dear.

Similar to the Great Lakes Region, we particularly enjoy hunting in under-scouted areas to begin with. The best players in the draft are analogous to the S&P 500, the group of the biggest and best companies in the U.S. Those 500 blue chippers have an average of 20 scouts following each company. The scouts in this case are Wall Street analysts. By comparison, the portfolio that we manage currently is made up of 50 stocks with an average of only 9 scouts per company following them. Almost one-third of our stocks are followed by five or fewer scouts (all numbers according to our friends at Thomson).

Price measures popularity, in ballplayers and stocks. The average market value of stocks in a dollar weighted S&P 500 Index is just under $90 billion per company as of this writing. By comparison, over 90% of our holdings are below (well below) that size. What is the point? The emptier the stadium of scouts and the more unrecognized the company, the more chances we have to find something others will not. The blue chippers attract all of the attention in any sport. Wal-Mart (WMT) is followed by 21 scouts, Cisco Systems (CSCO) has 22 scouts, General Electric (GE) has 19 scouts, and Johnson & Johnson (JNJ) has 23 scouts. If you take the sum total of all their scouts' different opinions you would see the very highest 2006 earnings per share estimates compared to the very lowest are separated by a grand total of 30 pennies, combined!!! That comes out to an average difference between the extreme hi-low estimates of only 3% based on earnings per share, and it took 85 teams of analysts, countless hours and countless millions to create these " different opinions."

We believe the best ballplayers and the best companies do not often make the best investments because we are not looking for the most agreed-upon estimates; we are looking for the most disagreement.

"When I started writing I thought if I proved X was a stupid thing to do that people would stop doing X. I was wrong."
Source: Moneyball, Michael Lewis

We believe this last quote is the most fascinating and timeless lesson from the book and from the story on Wall Street. No matter how much proof you have to support doing something a different way more successfully, people still like doing things the way they always have. This provides the mother of all misperceptions, and what we enjoy working on every day.

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