The crack as the bat hits the ball, the roar of the crowd, the crunch of cracker jacks…ah, the sounds at the ballpark.
In years past, greats from Babe Ruth and Willie Mays to Barry Bonds and Ken Griffey Jr. captivated generations of baseball fans. But today, many of “the boys of summer” aren't as well-known or household names. And, difficult as it may be for diehard fans to admit, baseball may no longer be considered “America’s pastime.”
So, what changed?
Three main factors appear to have propelled baseball’s unfortunate skid. These include a home run bias, overpaying for success, and short-term thinking.
While thinking about baseball’s circumstances, we found striking parallels to pitfalls in long-term investing. Whether recklessly swinging for the fences, overpaying for stocks whose performance doesn’t measure up over time, or falling victim to short-term thinking, some investors have found themselves in a run-down between first and second with little chance of reaching either base safely.
So what can baseball’s slump teach investors?
A grand slam of miscues
Several theories about the shift in baseball’s popularity have bubbled to the surface.
- Some believe baseball has become too focused on the long ball, failing to diversify its hitting strategy to consistently and reliably score runs. (This may be why Major League Baseball put in new rules to limit the shift and increase the size of the bases.)
- Others point to teams overpaying for “star” players, willingly giving up lots of prospects, and offering high, long-term guaranteed contracts to win today.
- A third theory hypothesizes that a win-now philosophy overrides a long-term team-building strategy for ongoing success.
Investors can learn from baseball’s errors. Let’s take a look at three lessons you can apply to your long-term investment strategies.
Lesson 1: Solely relying on home runs is not, in our opinion, a winning strategy
When players swing for the home run, they have a greater chance of scoring a run (1 hit = 1 run), but they also increase their chances of striking out. On the other hand, high percentage hitters take a different approach—they try to make contact, pull the ball into the gap, and get a hit. A winning strategy combines both players who get on base and power hitters who drive them home. You can use that same logic for your stock investment strategies.
Some companies deliver high growth. Others offer consistent returns. But a select group of companies does both. We believe that these high-quality companies produce reliable, robust, and sustainable growth over time. How? These businesses should increase market share, raise prices, and continuously innovate through products and services that offer compelling competitive advantages. As a result, Quality companies that provide reliable and sustainable growth generally have the potential to outperform the market.
So just like swinging for the fences results in frequent strikeouts, low-quality companies tend to have unsustainable growth. In our opinion, high-quality companies can potentially deliver both consistent returns and sustainable growth. Now that’s a winning formula.
Lesson 2: Valuation matters
How do you value a player’s worth? Overpaying—especially if a player underachieves expectations—can negatively impact a team, even years down the road. That’s because committing too many resources to one player often hamstrings the team’s ability to acquire and pay other players. But if the player’s contribution outweighs his costs, then the high return on investment may justify the generous salary. Valuation is just as important in investing.
Is paying $1000 for a share of company XYZ a good investment? It depends. Using a valuation multiple can offer perspective.
Multiples help investors understand a company's relative attractiveness—typically comparing it to similar companies, the overall market, or its historical trend. Price-to-earnings (P/E) is a commonly used one.
If P/E is low relative to similar companies, then its stock may be considered cheap and a good buy. Conversely, it may be expensive if it’s high relative to peers.
How should you evaluate a stock’s value? No valuation metric is perfect. For example, P/E doesn’t do a good job of capturing growth potential. So some investors use P/E to growth (PEG) instead. But because companies can manipulate earnings, other investors prefer valuing companies on a multiple of cash flow. Regardless of the chosen metric, we believe it’s essential to use the same one consistently.
It’s also important to remember that a multiple is only one data point. It doesn’t give the scouting report—tell the story of why the stock may be cheap or expensive. That’s where fundamental analysis comes into play.
Lesson 3: Short term is short-sighted
At baseball’s trade deadline, teams determine if they should be buyers or sellers. If a team is playoff-bound, it may look to add a player to satisfy a short-term need. Conversely, clubs that will not make the post-season may be willing “sellers.” This supply-demand dynamic makes a market. But because many clubs are focused on the near term, they fail to build a team for long-term success. Instead, they relinquish good prospects to get a player that fits today’s needs, depleting their farm system and hurting their chances for future achievements.
Short-term focused investors may similarly pass up sustainably strong companies to chase a hot stock of the moment. This mindset often results in heavily concentrated portfolios in particular geographies or industries and built on past successes with little attention to future growth.
Instead, we believe prudent portfolio construction is about finding the best companies—through bottom-up stock selection. But it’s also about having a top-down view—of the economy or a particular theme. We think that a well-constructed portfolio uses both bottom-up and top-down analysis to understand the interconnectedness of its components. The purpose? To diversify or spread risk so that the portfolio does not have unintended high levels of exposure to any company, industry, sector, or geography.
Rounding the bases
Baseball is hard. That’s why getting a hit just one-third of the time is considered a very successful average. With so much pressure, teams can easily stumble into many of the pitfalls afflicting the game. But for the teams built for the long-term—with the right philosophy, people, and structure—a winning strategy should emerge.
We believe investors should take the same approach to long-term investment strategies. Because we have the conviction that building wealth with stock investing is not about swinging for a home run and striking out just as often. Instead, we think it’s about finding sustainable companies that hit the mark consistently and are more careful about what swings they choose to take.
It’s about playing small-ball—with the occasional, appropriately timed big swing—which we believe pays off over the long term… structuring a portfolio where the pieces work together to mitigate risk while delivering returns that potentially compound over time. And it’s about properly vetting the manager and trusting that they put their client’s best interest first.
So while baseball struggles to get out of its slump, it’s our view that taking heed of these lessons hopefully means investors can round the bases and score on their investments.
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