It was a cold and snowy day yesterday which isn’t uncommon this time of year in the Rockies, actually many of the heaviest snowfalls of the year occur in April. But last night I was able to see Moneyball which is movie starring Brad Pitt and based on the experiences of Billy Beane who’s the general manager of the Oakland A’s baseball team.
The movie captured the highs and lows of the A’s 2002 season in which they found themselves losing three key free agents to larger franchises and trying to find a way to cope with the realities of being a franchise with a $35 million dollar payroll competing with teams like the Yankees who at the time had a $120 million payroll.
Due primarily to one of the strongest unions in the country: the MLB players union, a salary cap on team payrolls is nonexistent and has made for an unfair, unlevel playing field between large market teams (Yankees, Red Sox) and small market teams (Royals, A’s, Padres for example).
Billy had to find a way to replace his stars with players who could contribute enough to make up for the loss in production yet be cheap enough to fit within his payroll. He simply could refit the roster with high priced free agents or trade for players with large contracts, there was no question he couldn’t expand his player payroll budget.
Baseball has long been a sport in which scouting has played a significant role. Scouts were frequently older baseball men who used their experience to extrapolate what a young players potential could be. The process is highly subjective and as in most professional sports, most of the prospects never make to the major leagues let alone be stars. Billie was tired of hearing the old phrases “he’s built like a ballplayer, a five tool player, a smooth level swing, and he’ll improve with time”. All Billy wanted to know was: “Can the kid get on base?” If the kid can’t get on base, be it from a walk or a hit he’s of little use to the team and all the pat phrases from the scouts won’t mean a thing.
While visiting the offices of the Cleveland Indians in an attempt to make a trade his offer is shot down based on a mouth to ear relay of information to the Indians GM from an unlikely looking young man. This young man was one of the first to use data analysis to formulate opinions on their young players.
This young man catches the eye of Billy Bean because is on the cutting edge of incorporating data or quantitative analysis (QA) to determine if the player had the potential to contribute. The young man didn’t care if the player could even field his position he only cared about his on base percentage (OBP).
The use of quantitative analysis (QA) in baseball was the brainchild of Bill James. Eventually the use of QA in baseball spread, even to the large market teams like the Red Sox who in fact are owned by John Henry who is a proponent of QA in managing his hedge fund. However, to this day the issue of QA is still contested since baseball is an old school sport where change rarely occurs and jobs are entrenched.
But this isn’t really a post about baseball as much as it is a post on the advantages of quantitative analysis in many of life’s endeavors especially investing.
In place of the subjective “it has a great looking chart” / “the stock has a low PE and a 2% dividend and we expect it to move 20% higher this year!” is our proprietary RMHI model that allows us to backtest over a decade of data to determine which balance sheet profiles and stock selection formulas actually work in creating above average shareholder wealth. Can this stock “get on base?”
In baseball the large market teams are captivated every year by the super stars that hit the free agent market just as investors are fascinated by the attention getting stocks such as Apple. The past does not equal the future and while the Angels may feel adding Albert Pujols to their roster for an average of $25 million a year till 2021 is a good deal, you must consider he is a richly valued player who is peaking at age 32. Will he be able to contribute at ages 38 to 41? For every Ted Williams there are many more Manny Ramirez’s who were done at 38 leaving the team stuck with a dead money contract.
But investors miss the questions they should be asking themselves: Is my chance of making an above average return on Apple (which sells at 17x 2012 eps, 4.4 times revenue and 6x book value) better going forward than shares of a stock selling 9x 2012 earnings, 0.46 times revenue and .75 times book value). This is the essence of Moneyball or as a wise man once said to me “Price is what you pay and Value is what you get”. FYI the unnamed stock is Voxx International, symbol VOXX.
And the Oakland A’s won their division in 2002 with a better record than the year before.