Billy Beane was a monster.
Coming out of high school in 1979, he was the premium baseball player. He could run, he could field, he could throw, and he could hit with power.
Such a combination doesn’t come along very often.
Every team wanted Billy to play for them. It’s why at the fresh age of 18, baseball teams were estimating that Billy was worth six figures.
By this point, all the scouts had seen was Billy play in high school. But that was enough. If Billy was half as good as he was in practice, he was worth the money.
Instead of going to Stanford on a full athletic scholarship, Billy decided to sign with the New York Mets. He received a US$125,000 signing bonus (worth around US$371,000 today).
But that’s went Billy’s life took an unexpected turn.
As soon as Billy got to the big time, he choked.
He couldn’t adjust to the tougher competition. His batting average was lower than ever. Just five years later, the Mets traded Beane with two other players to get Tim Teufel and Pat Crosby, a couple of minor league players.
By 1990, after multiple trades and constant stress, Billy found himself at the Oakland A’s. He’d had enough. In the 1990 season, Billy no longer had the desire to play. He went to management and asked to be let go.
He was not leaving the A’s, Billy told them. He wanted to be a scout. After seven years, Billy was promoted to General Manager of the A’s. And as manager of the front office, Billy had the greatest impact on baseball that any man ever has.
Billy revolutionised how teams picked their players.
I’d like to stop here for a minute and ask a question.
How would you construct a baseball team?
Would you just try to get the best players on your team? Having the best pitcher, best batters and best fielders is surely going to win games…
But who are the best players? Like the scouts picking Billy in 1979, most would approach the problem subjectively. Just take a look at how the boy hits, fields and throws. If it all looks good then that box is ticked.
Yet this might have just been a good day. What if on an average day, or up against tougher competition, the player crumbles…like Billy.
The sad fact is, many investors take this approach to constructing a portfolio as well. They look at ticks, glance at earnings and deem if the trend is favourable or not.
If it is, then the stock is good enough to buy.
And with such a strategy in the market, investors end up like the Mets — paying a lot of money for an asset (Billy) that didn’t live up to expectations.
So how do you build a winning baseball team and a winning portfolio? Let’s go back to Billy.
Eight Simple Steps: How to start making money the ‘Warren Buffett’ way. Get your free report.
Wins equal money
What’s most important to a baseball team?
Wins not only lead to championships, but are the recipe for dedicated fans. It’s the secret sauce that sells merchandise. And most importantly, it’s the formula behind riches.
Sure we want to see healthy competition out there. We want the fans to enjoy themselves. But make no mistake; baseball, like all other sports, is a business.
Wins equal money. And if you can get those wins at a lower cost then you make more money.
But wasn’t that always the goal — to get wins? I’m sure it was for many of the scouts in the 1980s. But they just didn’t go about it the right way.
The league thought you could get wins by simply drafting the best players. And as you saw, ‘the best’ can sometimes be extremely subjective.
Instead of looking at his players as star athletes, Billy decided to define his players by the number of runs they could get. More runs would mean more wins. You weren’t paying for a player. You were paying for the runs he could produce.
This strategy worked perfectly for the A’s limited finances. They couldn’t offer big baseball stars millions of dollars. If they did, they wouldn’t be able to afford the rest of the team’s salary.
So Billy decided to look through the bin of discarded players. What he found was remarkable.
Many of the players could get him the runs he needed (based on career averages). Teams just weren’t willing to pay up for these players because of their age, attitude or some other subjective reason.
In the radical change, Billy would also optimise his own team. Many of his ‘best players’ weren’t worth the runs they produced. So he traded them.
Billy built a playoff team that won more games without these ‘best players’. In the 2002 season, the A’s also won as many games as the New York Yankees (103). But the Yankees would spend US$1.4 mln per win. Billy only spent US$260,000 per win.
Every baseball, football and other major sports team now follows Billy’s model. They all hire statisticians to work out the odds of success and how much a player might be worth.
Investing is about playing the odds
If we relay this to investing, it’s all about playing the odds. Sure, the odds of an event might be subjective at times. You might have limited historical data to go off.
But playing the odds is a far better strategy than looking a company up and down before buying. As an example, say you had two options: Investment A and Investment B.
Investment A is a star investment. Past growth has been amazing and a majority of the market has bought it. The odds of Investment A exceeding its growth expectations and justifying its price are 35%.
Investment B is also a pretty good investment. But it’s not in the ‘hot industry’. Investors don’t really think much about its long-term prospects. Yet you believe the chances of Investment B exceeding expectations is 85%.
If the payoff for Investment A is a 20% annual return for 10 years and the payoff for Investment B is a 15% annual return over the same time, which do you buy?
By multiplying the odds of success by the expected payoffs, you’ll see Investment B is better. Investment A has an expected annual return of 7%, whereas Investment B has an expected annual return of 12.75%.
Keep in mind this is a simplistic example to demonstrate the point. But it shows how you can build a winning baseball team and portfolio at the same time.
Editor, Money Morning
PS: Eight Simple Steps to Invest Like Billionaire Warren Buffett… Get the steps now (free).