Investing Caffeine

What Happens in Vegas, Stays on Wall Street

August 29, 2010 at 11:53 pm 1 comment

What happens in Vegas, stays in Vegas, unless it’s a habit of betting, in which case that habit will follow you back to Wall Street. Just as there are a million ways to make or lose money by investing or speculating in the market, the same principles apply to sports betting as well.  Anybody who has been to Las Vegas and gone to the sportsbook knows how incredibly and insanely accurate the oddsmakers are – I speak from immature experience having traveled there for a healthy number of investment conferences and vacations. The oddsmakers are so accurate; you could say they are almost “efficient” at what they do.

 But like the market, in the sports world too, efficiency has a tendency to breakdown occasionally and form bubbles. This dynamic leaves both a huge threat of substantial losses and a potential for windfall gains. Where there are bubbles forming, you are bound to find a large number of excited individuals jumping on a bandwagon. Now, let’s take a look at how the worlds of Wall Street and wagers collide and see if any lessons can be learned.

Jumping on the Stock Bandwagon

band·wag·on [band-wag-uhn]: a party, cause, movement, etc., that by its mass appeal or strength readily attracts many followers.

Photo source: Freshpics.blogspot.com

Everybody loves a winner and no one more so than a fresh fan jumping on the bandwagon. Living in Southern California, the bandwagon is presently fully-loaded with proclaimed Los Angeles Laker fans and USC fans, although the Trojan wagon is currently undergoing repair. It’s easy to identify bandwagoners in sports – just find the face painter, guy with a rainbow afro, Boston native sporting a Kobe Bryant jersey, or the fanatic betting on the team favored by three touchdowns. In the game of stocks, identifying the fickle but passionate followers is a little more subtle. Bandwagon status is not measured by the extent of point spreads (predicted scoring differential between two opponents), but rather by level of P/E ratios (Price-Earnings ratio) or other valuation metric of choice.

While it is clear sports bandwagoners root for the “favorites,” in the realm of investing this translates into piling onto the “growth or momentum” stocks (see Momentum Investing article) – I hate generalizing terms but that’s what we bloggers do. Value investors, on the other hand, root for (buy) the “underdogs.”

To illustrate my point, let’s take a look at a few past bandwagon momentum stocks:

• JDS Uniphase Corp. (JDSU): In 2000 we saw these bandwagoners valuing investor favorites like JDS Uniphase at a whopping $99 billion – meaning investors were willingly paying over 100x’s revenues and 600 x’s trailing earnings to own the stock. At the time, JDSU was a “New Economy” stock that was going to revolutionize the proliferation of bandwidth around the globe with their proprietary optical laser components. For those of you keeping score at home, today JDSU’s stock is valued at approximately $2 billion ($9.97), or -98% less than the market value in March 2000 (split-adjusted peak share price of $1,227.38 per share). If it wasn’t for a 1-for-8 reverse stock split in 2006, then a share of JDSU would fetch you $1.25 today, or less than the amount needed to cover an out of network ATM penalty fee.
• Crocs Inc. (CROX): Crox is another one of my favorite bandwagon stocks, because this loud plastic eyesore footwear was clearly a fad that couldn’t sustain its growth once popularity waned, despite my wife being a bandwagon-ee.  Like other fad product-related stocks, the company could no longer maintain its growth once they completed stuffing the channel and their customers cried uncle from choking on inventory. Making matters worse for CROX, knockoff versions were offered for a fraction of the cost at local grocery stores and mall kiosks. After about 20 months post its IPO (Initial Public Offering), the music stopped and within 13 months the stock cratered from a $75 per share peak to $0.79 in 2008. The stock never traded at the absurd dot-com levels, but the lofty 37x P/E in 2007 quickly turned negative after close to $200 million in losses were realized in 2008 and 2009. The stock has since rebounded to $12 and change, and maybe their new Crocs high-heel line of $99.00 shoes (see here) will propel the stock higher…cough, cough.

Point Spread, Point Spread, Point Spread

In sports betting the three most important factors in making a winning bet are point spread, point spread, and point spread. Unlike the March Madness college basketball pool in which you may have participated, in the real world the participant needs to do more than just pick the winning teams – the participant must determine by how much a team will win by. Let’s take a gander at a few actual examples.

• Florida Gators vs. Charleston Southern Buccaneers (9/5/09): Without knowing a lot about the powerhouse squad from South Carolina, 99% of respondents, when asked before the game who would win, would select Florida – a consistently dominant national-powerhouse program. The question gets a little trickier when asked the question: “Will the Florida Gators win by more than 63 points?” That’s exactly the point spread sports bettors faced when deciding whether or not to place the bet – somewhat analogous to the question whether JDSU was a prudent investment at 600x’s earnings? Needless to say, although the Buccs kept it close in the first half, and only trailed by 42-3 at halftime, the Gators still managed to squeak by with a 62-3 victory. Worth noting, the 59 point margin of victory resulted in a losing wager for anyone picking the Gators.

• USC Trojans vs. Stanford Cardinal (10/6/2007): Ranked as the presumptive #1 team of the country pre-season, and entering the game with a 35-0 home-game winning streak, USC was a whopping 41 point favorite over Stanford. On the flip side, the Cardinal came into the game fresh off of a 1-11 losing season the prior year, and in the previous year the Cardinal lost to the Trojans 42-0. Stanford ended up winning the 2007 match-up by a score of 24-23, not only pulling off one of the greatest upsets of all-time, but also spoiling USC’s chances of winning the national championship.

Read more about the greatest upsets of all-time.

Beyond the Point Spread

As you can surmise from our discussion, the same point spread standards apply to investing, but when discussing stocks the spread is measured by various valuation metrics based on earnings, cash flows, book value, EBITDA, sales, and other fundamental growth factors.

Of course, in Las Vegas and on Wall Street not everyone follows traditional fundamental analysis. Some gamblers and speculators will transact solely based on less conventional methods, for example quantitative models, technical analysis and trend review (read Technical Analysis: Astrology or Lob Wedge). For example in sports, handicappers may only wager on teams with five-game winning streaks and winning home records. Whereas on Wall Street, speculators may only trade stocks with positive earnings surprises or “head-and-shoulder” patterns. Hot technicians come and go, but very few real investors survive the long haul without using fundamental analysis and valuation as key components of their winning strategies.

As I have argued, there are many ways to make (and lose) money on Wall Street or in Las Vegas, and consistently jumping on the bandwagon is a sure way to lose. For the successful minority whose performance has endured the test of time, a common thread connecting the two disciplines is the ability to determine and profit from a prudently calculated point spread/valuation. History teaches us that the same effective handicapping skills happening in Las Vegas are the same abilities needed to stay on Wall Street and win.

Wade W. Slome, CFA, CFP®  

P.S. See how a pro handicapper conquered Las Vegas and placed sportsbooks on the run.  

Entry filed under: Education, Stocks. Tags: betting, bubbles, Florida Gators, handicapping, investing, momentum investing, point spreads, sports, statistics, UCLA, USC Trojans.