Tuesday, February 21, 2012

Moneyball and the Markets

I have seen recent writings drawing comparisons between investment activity and the actions which form the basis of the movie “Moneyball”. Much of these comparisons make sense: the search for metrics that accurately reflect reality instead of some cacophony of hunches driven by intuition and superstition.

However, the primary lesson to be learned from the book (or the movie, but as the saying goes, “the book was better”) is that ever-changing cycles move the “right” metrics so that most participants over-pay for the privilege of owning them.

For example, Billy Beane (the GM of the Oakland Athletics) used On Base Percentage as his governing metric and built a team that enjoyed massive success relative to its meager payroll. But, as competitors recognized something was afoot, his methods were quickly found out and he had to find different metrics that were undervalued just as On Base Percentage was becoming overvalued. Thus, Mr. Beane moved his value-finding operations to defensive metrics and purchased players accordingly. Competition had moved the game, raising the price of OBP and lowering the relative price of other abilities.

The same can be said regarding NFL receivers. The current meta of the game reinforces tall, large framed wide receivers such as Calvin (“Megatron”) Johnson of the Detroit Lions. These players have indisputable impacts on the game, but are becoming more and more expensive for teams to purchase. The value of their physical characteristics are becoming overpriced. Clones of Mr. Johnson (he is 6'5" and 240lbs.) will be found given current prices. They have to be. Supply is irresistably attracted to high demand and high prices.

Conversely, the leading wide receiver in the NFL in terms of catches actually caught, Wes Welker , fills out the uniform at 5'9 and 185 lbs and was paid $2.15 Million in 2011. His physical characteristics, and those receivers who are like him, are currently undervalued. How undervalued? Mr. Johnson was paid $8.75 Million in 2011, 4 times as much as Mr. Welker. Thus, teams now in the NFL who will be successful in the coming decade will begin to purchase smaller, more agile players who will gradually become more and more important to the NFL meta game until they become overpriced again and the cycle is reset.

In addition, these changes will effect defensive personnel as well. Tall cornerbacks are in huge demand at the moment to defend the latest influx of tall and physically imposing receivers and they have met with success. Once again, the supply will be found and the effectiveness of tall wide receivers will diminish. The best run NFL teams realize this already and will begin to outfit their team with smaller players that will simply be too agile for larger cornerbacks to contend with. (or explore other means to fatigue the larger players, such as No-Huddle offenses)

And so it goes with investing. By the time anyone reads in popular newsprint about the “newest” way to value stocks, it is too late. Moreover, this “new” metric is invariably just a re-packaging of something used many times in the past, to say nothing of the fact that often times they are floated by larger fish that wish to sell what is now overpriced. It was always thus.

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