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Investing in Beane Futures
2003-10-02 08:50
by Jon Weisman

Or, extracting the Money from Moneyball...

Steve Galbraith, Chief Investment Officer at Morgan Stanley and Red Sox fan, has published a report about investing, "Searching for the Financial Equivalent of a Walk," using theories from Michael Lewis' baseball book, Moneyball.

You can imagine Galbraith probably isn't too excited about discussing anything to do with the A's this morning, but here are some excerpts from his report:

The book revolves around the seemingly inexplicable success of the Oakland A's, who, in finance terms, consistently and significantly outperform the market with players (stocks) that other teams (investors) deem rejects. The added twist to the story is that the A's General Manager, Billy Beane, was a former wunderkind whom scouts once viewed as a can't-miss propsect - a kind of Enron of the sandlot if you will...

The beauty of the baseball-team-as-stock-portfolio analog is that, as with money management, both growth and value styles have shown an ability to win. As much as we hate to admit it, the Yankees, with their absurdly high-P/E players, have consistently outperformed the market. In contrast, the Mets, with equally high P/E's, have massively underperformed. Conversely, the A's, made up of players trading below book value, have continued to shine, while Tigers fans seem to be getting just what their management is paying for - the 1962 Mets...

Nevertheless, Galbraith writes that growth stocks are the "financial equivalent of a .280 hitter with a .290 on-base percentage." (Looks like Tampa Bay's Carl Crawford is your growth stock of the year.)

Everybody "knows" the bullet-tossing prom king will be a success, so scouts overpay for him. Investors similarly fixating on growth rates are often playing in a picked-over field. If high degrees of success have already been achieved or are forecast, where's the upside...

What is an even more obvious way of underperforming than drafting a strapping slugger who runs a 4.40 40-yard dash or a company that has achieved wonderful recent success in increasing earnings. How about buying a stock that has just gone up - a lot...

In baseball terms, walks = success. But walks are boring. Walks are passive. Walks do not illicit oohs. As such, walks are grossly undervalued ... Price to earnings, price to sales, and yup, even price to book are the financial equivalents of walks. Again, if one were to buy systematically the cheapest quintile of sotcks on these metrics while selling short the dearest, one might enjoy an early retirement...

Moneyball has confirmed to us that baseball is not only a metaphor for life, but also for finance. Just as being a Red Sox fan prepares one much better for the realities of life than being a Yankees fan, understanding the nuances of baseball can translate to the nuances of investing. In both fields, sizzle is vastly overrated. In an era characterized by corked bats and corked financial statements, give us steak, give us walks, give us cheap stocks.

The thing about this report is, the people who would really benefit from it are baseball team officials - and certainly the media covering those teams - more so than your average investor. Many baseball insiders have misinterpreted Moneyball (assuming they read it at all), thinking it a book merely about the virtues of on-base percentage, rather than what it is - in fact, a book about making good investments.

Perhaps this report is a way to get them to understand. It's about value. The name of the game is not always the names of the game.

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