The Moneyball Approach to Equity Investing

Julian Koski, Co-Founder and Chief Investment Officer, New Age Alpha
Nov 26, 2019 11:48:32 AM 3 min read

You may recall a  bestselling book and feature film called Moneyball. It was a story about building a professional baseball team by taking a quantitative approach. In the early 2000s, Oakland A’s manager Billy Beane was facing the challenge of putting together a winning team with a low payroll. To do so would require entirely new strategy. I always liked the story because of some strong parallels I saw between that approach and how I believe stocks should be selected.

For one thing, it showed that human judgement is flawed. Traditionally baseball scouts relied on outdated rules of thumb and instinct far more than they relied on statistics. And the statistics that they did use were themselves outdated and generally unreliable. It was the intangible qualities of a player that the scouts were concerned with. Yet this approach introduces an enormous amount of human bias and emotion.

Thinking differently by thinking for yourself

Maybe Beane could find undervalued players – players that other teams didn’t appreciate because their intangible qualities didn’t stand out. Maybe if he looked at things completely differently and abandoned the old ways, he stood a chance. With the help of some Ivy League mathematicians, he set out to make the most of his low payroll by relying on probabilities rather than gut. The result was a revolution in baseball thinking. 

The key to this new approach was a combination of thinking differently, refusing to try to outguess the competition and focus on value. It relied on facts and the knowable and disregarded the unknowable future. While other teams stubbornly put all faith in their scouts’ gut instincts, the Moneyball approach focused on a player’s proven ability to perform and in the end actually took advantage of the competition’s sketchy subjective analysis. Often teams would discount a player for reasons that made little sense, like being left-handed. These were the players to acquire. And when the competition overvalued and offered to overpay for a player with superstar status but merely above average performance, it was fine to pass.  

Like Warren Buffett has often said, there are no called strikes in investing. To strike out, you must swing and miss.

Wait for the fat pitch!

Consider what happened when the Los Angeles Angels decided that Albert Pujols should be acquired in early 2012. The ten-year veteran player stood out in every way, but was he worth the unthinkably high price of $254 million over ten years? Yes, Pujols was a superstar player by every measure, but how does this investment translate into success? Would the team go all the way? Eight years later, we can evaluate in hindsight. Pujols’ best year with the Angels was 2012, and the Angels have only made the postseason once since his arrival. In other words, $254 million could have bought a lot of young prospects.

I believe money management in particular purchasing shares is facing the same sort of reformation that occurred in baseball. The old ways simply need to be rethought. Instead of trying to predict the future, we should be focusing on what we know for sure. In the stock market this means the history of performance and the stock price. This takes the guesswork out of stock picking. It also keeps those pesky human emotions from causing delirium (or dejection).

And when the market gets fanatical about a high-growth company but also assigns it an exorbitant valuation, stay away. Even Albert Pujols, after all, was not worth the price paid. 

CC: NAA10023

Julian
Kern
Co-Written by Julian Koski, Co-Founder and Chief Investment Officer and Andy Kern, Senior Portfolio Manager