Equity Life Cycle: The Moneyball Approach
Building a portfolio of stocks is a little like assembling a baseball team. However, unlike a team of real baseball players, constructing a portfolio of stocks can mix low-priced single-A farm players with blue chip Hall of Fame players from the Majors. Billy Beane, the General Manager for the Oakland Athletics, was chronicled in Michael Lewis’ book, Moneyball. Beane creates an amazing proprietary system of building teams more cost-efficiently than his deep-pocketed counterparts by statistically identifying undervalued players with higher on-base and slugging percentages. According to Beane, traditional baseball scouts were overpaying for less relevant factors, such as speed (stolen bases) and hitting (batting percentage).
In the stock world, before you can scout your team, you must first determine where in the life cycle the company lies. If Beane were to name this quality, perhaps he would call it Time-to-Maturity (TTM). Some companies operate in small, mature bitterly competitive industries (e.g. shoe laces), while others may operate in large growing markets (e.g. Google [GOOG] in online advertising and algorithmic search). Some companies because of negative regulation or heightened competition have a very short life cycle from early growth to maturity. Other companies with competitive advantages and untapped growth markets can have very long life spans before reaching maturity (think of a younger Coca Cola [KO] or Starbucks [SBUX]). Like Beane talks about in his book, many young, promising, immature baseball players flame out with short TTMs, nonetheless many scouts overpay for the cache´ such players offer.
Unfortunately, many investors do not even contemplate the TTM of their stock. Buying juvenile stocks (i.e., private companies like Twitter & Facebook – see article) or elderly stocks in and of itself is not a bad thing, but before you price a security it’s advantageous to know what type of discount or premium is deserved. Obviously, I’m looking for undervalued stocks across all age spectrums, however finding an undervalued, undiscovered late-teen just beginning on its long runway of growth combines the best of all worlds. Finding what Peter Lynch calls the “multi-baggers” is easier said than done, like searching for a needle in a haystack, but the rewards can be handsome.
What creates long runways of growth – the equivalent of winning dynasties in baseball? Well, there are several contributors leading to longer TTMs, including economies of scale, large industries, barriers to entry, competitive advantages, growing industries, superior and experienced management teams, to name a few factors. But like anything, even the great growth companies, including Microsoft (MSFT), turn from teenagers to mature adults. As famed businessman Thomas Brittingham said, “A good horse can’t go on winning races forever, and a good stock eventually passes its peak, too.”
There are many aspects to creating a winning team. If Billy Beane were to draw up factors for a baseball team, I’m confident TTM would be near the top of his list. What you pay for the length of the growth cycle is obviously imperative, but since I’m a strong believer in the tenet that “price follows earnings,” it only makes sense that above average sustainable earnings growth should eventually lead to superior price appreciation. As Bob Smith, successful manager from T. Rowe Price states, “The important thing is not what you pay for the stock, so much as being right on the company.” So if you want to recruit a portfolio of winning stocks, like Billy Beane picks successful baseball players, then include the equity life cycle maturity statistic as a factor in your selection process.
Wade W. Slome, CFA, CFP®
Plan. Invest. Prosper.
DISCLOSURE: Sidoxia Capital Management nor its client accounts have no direct position in MSFT, SBUX, KO, Facebook, or Twitter shares at the time this article was originally posted. Some Sidoxia Capital Management accounts do have a long position in GOOG shares. No information accessed through the Investing Caffeine (IC) website constitutes investment, financial, legal, tax or other advice nor is to be relied on in making an investment or other decision. Please read disclosure language on IC “Contact” page.