What Baseball and Finance Share

A Litte Baseball
Baseball before Moneyball

In a word: stats.  Baseball has statics for almost anything of relevance that happens on the field.  Finance has statics like expense ratio, yield, price-to-earnings ratio, total return, alpha, beta, R-squared, Sharpe ratios, and the Greeks (delta, vega, theta, rho)… just to name a few.  I  suspect most of my readers are more familiar with baseball stats like batting average, on-base percentage, slugging percentage, OPS, ERA, K%, BB%, GB, and the like.

Today’s blog will start with the simple concept of batting average.  In baseball batting average is the number of hits divided by the number of official at bats.  Since a typical baseball player can have 400 at bats per baseball season, there is a lot of statistical significance to his batting average for one year.

In contrast, a fund manager could be said to have about 4 at bats per season — one per quarter.  It would take a 100-year career to have as many “at bats” as baseball player has in one.  Even if you decided to count fund performance on a monthly basis, it would take 25 years to match a baseball season’s worth of data.

The most common financial definition of batting average counts a hit as outperforming the market (say the S&P 500) over a given time period, say 3 months.   An out is under-performing the market.  Generally a .500 batting average is analogous to the the Mendoza line in baseball.  Sadly, many fund managers and financial planners bat below .500.   And often those that do exceed .500 get there by early luck… luck which generally fades (back below .500) with time.

Just like in baseball batting average is not the most useful static in finance.  OPS (on base plus slugging percentage) is probably a better financial stat… if it existed.  Instead financial stats like Sharpe Ratio and alpha fulfill a similar role of financial performance measurement.  The problem with all these financial stats for measuring fund managers is there are simply not enough “plate appearances” to reliably measure a fund manager’s performance until his or her career is almost over!   It is only after a long financial career that the difference between skill and luck can be accurately sorted out… a bit late I’d say for investors looking to pick fund or fund managers.

There is a factor other than stats that financial and baseball matter share.  In a recent conversation someone mentioned that baseball is the only major sport where the player scores [directly].  In other words the runner himself (herself) scores by getting safely to home plate.   Basketball, football, and hockey require an object (ball or puck) to cross a threshold.  Football requires a ball + a player to score a touchdown, but a field goal does not directly require a player to fly through the uprights!  Only in baseball does the player himself score a run.

This analogy can be extended to the idea that the investor herself can be the only thing that matters (that scores).  At the end of the day it the investor who determines how successful she is at meeting her financial goals.  The Sabermetrics of finance may help her get there, but ultimately it is the investor herself who has a winning, losing, or World-Series-Championship financial season.

Financial Blog Year in Review

I’m starting to look back on 2011 numbers for the Balhiser Investing Blog.  The first thing that caught my attention is this investing blog has been visited by all 50 states except Wyoming.  Thanks all other 49 states for taking a browse.

I’ve been reviewing which topics and blogs have been the most popular.  Computing beta was the most popular topic, followed by my CBOE visit, then financial baseball.  Popular searches were what CPI stands for, bitcoin inflation, entrepreneur jobs, possible investments and living below your means.

Some analytics stats are better than last year, some are worse.  The most improved stat was time per visit which is up 70% to 2 minutes and 6 seconds per visit.

Finally, the financial blog has passed 150 blog posts.  This blog post will be #156.

CPI Stands for Nothing Real; Wall Street Understands This

I do a lot of reading about financial matters.  Recently I was in Barnes & Noble and picked up the December 2011 copy of “Futures” magazine.  Browsing through it an article on investing and inflation caught my eye.  I bought “Futures”, took it home, and afterwards felt very happy about my $6.95 investment.

There were several interesting articles, and a few that did not strike my fancy… involving MACD and other technical analysis methods.  Overall I found it a worthwhile read.

First and foremost I found the reference to CPI-U and shadowstats.com to be the most exciting aspect of “Futures”.  I have long been a casual follower of ShadowStats (SGS) and I was pleased to see in print what I have seen online.  What Wall Street and many economic statisticians understand is that the government-reported CPI (specifically the CPI-U) has become a bogus indication of inflation.  CPI-U  remains relevant because of it is tied (directly or tangentially) into many things such as Social Security benefit changes, COLA and TIPS.  CPI-U is a “headline number”, but many on Wall Street use their own inflation models.  These Wall Street models routinely show CPI-U to understate actual inflation.

Here’s the deal.  U.S. Bonds today, while “safe”, simply do not keep up with inflation.  Their performance in taxable accounts is even worse.  The same holds for money markets and savings accounts.  This knowledge is part of the inside baseball of finance, that I like to call financial baseball.  For the investor that wants to keep up with inflation, this “inside knowledge” pushes them towards riskier investments including stocks (and stock ETFs), junk bonds, and international stock and bond investments.  The bottoms line is that investing is either more risk-prone or inflation-ravaged… or a combination thereof.

Occupy Wall Street

Wall Street is both a physical location and a metaphor for many things.  Wall Street is a metaphor for U.S. stock markets, stock markets, bond markets, futures markets, options markets, commodities markets, OTC markets, banking, investment banking, even business and CEOs…. the list goes on.

Even if the Occupy Wall Street movement has a financial focus, the term “Wall Street” is just too overloaded.   And that is assuming the folks gathered there are focused on financial institutions and markets.  Some are protesting the Federal Reserve, others the Government, others corporations, others still capitalism.  Most are upset about our crappy US economy.

I think much of America looks at the financial world as a mysterious black box, or as a series of opaque entities tied together in a labyrinth only a few now how to navigate.

Some view this financial black box as useful.  They invest in mutual funds, stocks, bonds, and ETFs.  They take out mortgages and buy insurance.  They trust their investment advisers, or go it alone and trust in themselves.

Others view the financial black box as a “wretched hive of scum and villainy”.  Some from this group are part of Occupy Wall Street.

I have many good things to say about the version of “Wall Street” that I use.   However, I am critical of many parts of Wall Street that I don’t use.   Number 1 on my sh– list are many (not all) financial advisers and stock brokers.  All too often they put people into funds that are commission-laden, undiversified, and unsuited to the needs of their clients, just to make a lot of extra bucks for themselves.  Number 2 on my list are financial analysts (many, not all) whose job seems to be pumping up investments for their proprietary trading beneficiaries.

Nonetheless there are many good things about “Wall Street” and US  markets in general.  Vastly lower commissions on (online) trades, decimal pricing, lower spreads, low-cost ETFs and mutual fund (esp. index and enhanced-index funds).  Free stock quotes and online research.

Back to Occupy Wall Street.  I might as well join (though not support per se) with some virtual protests.

  1. I want a full, independent, and complete audit of the the Federal Reserve and the US Treasury [no I am *not* a Ron Paul supporter].
  2. I want all shareholder initiatives that pass to be legally binding.
  3. I want, at a minimum, the right as an index ETF or mutual fund to have my portion of shares be abstain votes (e.g. the fund manager may not vote *my* shares).
  4. I want (and this is a stretch!) no exit packages for failed CEOs.  I’m fine for paying for real success, but I am not fine with paying for failure.  If a new CEO wants a financial exit package of more than zero dollars, I want a CEO with more self confidence.
  5. I want the government to get out of the bailout business.

If any of you Occupy Wall Street (or Occupy XYZ) folks want to use my protests, be my guest.

Entrepreneur in Training

Small Biz Business PlanWalking to the Rockies game yesterday, I was struck by the bustling entrepreneurial spirit on display.  From the myriad pop-up game-day parking lots (ranging from $25 – $40 per spot), to the ticket sellers (“I buy tickets”, means “I sell tickets”), to the independent street vendors outside the ballpark marketing peanuts and beverages for half the in-ballpark price.

I have been an entrepreneur in training for most of my life.  For much of that time I didn’t associate the term entrepreneur with what I was doing, nor would I have been able to spell it.  Yet there were several entrepreneurial things I did even before graduating from high school.

  • Ran a paper-route (at age 12)
  • Door-to-door newspaper sales.  To get more revenue and “signing bonuses”
  • Picked up odd jobs to make a few bucks.  Jobs like fence painting, baby sitting & lawn mowing
  • Traded collectible cards… for fun and for profit
  • Built a “sluice-box” and panned for gold

In college I did even more.  I was trading and auctioning collectible cards via Usenet and the Web… in addition to trading face-to-face.  I found that trading up (trading several lower-value cards for one or two high-value cards) was my most lucrative strategy for making money.  I had to give up my personal collector’s mindset; to be willing to break up my collections when good deals became available.    I learned to put together targeted, marketable, ready-to-use (turnkey) sets in order persuade folks to part with one of their rare, sought-after cards.  As I got more market savvy, I learned to trade high convenience for high value.  This helped hone my fledgling negotiation skills.

I built up a reputation as a trustworthy vendor/trader who represented the quality of my cards honestly, who mailed them promptly, and packaged them carefully so they arrived in good condition.  I was doing this before anyone ever heard of eBay.

In college, I developed a software product called Visual Math 3D.  Looking through my notes, the proposed company structure was:

EngimaSoft, a division of Paradigm Software, a branch of Millennium Corp.

No shortage of boldness there!  I see now that others have grabbed most of these names.  Good for them, they are good names.

Visual Math 3D had a logo and marketing pitch for the cover of the box.  Unfortunately, I had too much school work (and school play) to bring the software to market.  Had I been more business-savvy at the time I would have brought in one or two partners to help market the product.  Who knows… it could have grown into a competitor of Mathematica, AutoCAD, or Excel — it had aspects of all three.

I continue to be an entrepreneur in training.  I’ve learned a few things.

  1. Business cards:  I have business cards now! 🙂
  2. Smile, listen, and mingle.
  3. Listen to feedback.
  4. Keep your sales pitch short, then converse like a real human being, not a sales droid.
  5. Market both yourself and your company/venture.  Online and offline.
  6. Market to people who are actually interested.  Don’t waste time selling ice to Eskimos.
  7. Advertising.  A necessary evil.  Yes, you will likely have to part with some capital to grab the right people’s attention in a positive way.
  8. Branding.  Logos, tag lines, style.  Done right branding creates a sense of professionalism, familiarity, and trust.

Financially my most successful ventures have not been lofty, swing-for-the-fences efforts.  Balhiser LLC’s rental property has earned over $10,000 and prospects remain good.   The Sigma1 proprietary-trading group is currently up $2700, but markets are fickle.  My card trading activities netted about $1200 over 4 years.  My paper route earned about $1100 over 1.5 years.

Except for the rental property business, all my business ventures have been self financed and operated on shoe-string budgets.  They have also been part-time, night and weekend activities.  I have a full-time career in engineering, and while my employer hasn’t given me the golden handcuffs yet, I do wear a nice silver pair.  Thus entrepreneurship will continue to be a part-time activity

My entrepreneurial successes have been modest, yet I am undaunted (at least most of the time).  Today I am a minor league entrepreneur.   I believe that within the next ten years I am likely to make it to the majors, because I have good ideas, tenacity, and passion.  Luckily I know several successful entrepreneurs, and I listen to and learn from them.  They encourage and inspire me when I need a little emotional support.

Entrepreneurship is not for everyone.  It is difficult, if not impossible, to teach in a classroom; entrepreneurship must be experienced.  It can be fraught with setbacks and dead ends.  Passion can turn lead to burnout and frustration.  Yet entrepreneurship can be exhilarating, stimulating, empowering, fulfilling and fun.

Entrepreneurs continue to drive the US economy.   The best, most concise, most creative ideas come from entrepreneurs .  Entrepreneurs also deliver mundane, but necessary goods and services ranging from car washes, to restaurants, street-side baseball snacks,  and rental properties.

The entrepreneurial spirit is alive and well in the US.   Recessions wipe out jobs, and some of the unemployed try out an entrepreneurial path.  While many fail, some succeed.  Some that succeed thrive, and build the businesses of tomorrow.  These people create not only jobs for themselves, they create jobs for others.  They drive innovation and keep America competitive.

I am not expert on entrepreneurship, but I am an entrepreneur.  I work with other entrepreneurs and admire their spirit.  While Washington pays lip-service to entrepreneurs, it seems to be ignoring the obstacles it puts into place, impeding entrepreneurs:

  • Self-employment taxes.  Small business pays Social Security and Medicare twice on every dollar earned.  Even on the very first dollar.
  • Employment and payroll rules and regulations.  The red tape is one reason I hesitate to hire any employees.
  • Regulations.  The only reason my hedge fund is not open to the public (at least to select accredited investors) is the mountain of regulatory requirements.

Even against daunting odds and government red tape, entrepreneurs find a way.  There are many who let red tape and taxes cause them either not enter the entrepreneurial game or quit it out of frustration.  This is a shame, and a loss for the US economy.  There are those who give up one entrepreneurial path (their first) choice, to pursue an alternate entrepreneurial path.  This, too is a loss, but perhaps not a severe.  Finally, there are some small businesses that simply stop growing… not from lack of opportunity, but to avoid the deep, sticky, red tape of employment law.

Right now I’m the category of entrepreneurs who are forgoing (for now) my first venture: the Sigma1 Hedge Fund, and pursuing my secondary venture — financial blogging.  I have a couple accredited investors willing to invest with me, but I have told them for now to put that on hold.

It’s not that financial blogging is not enjoyable, it’s simply far more difficult to make reasonable profits from a finance blog.   Given a choice, I’d rather make $250,000/year from blogging than managing a hedge fund.  It’s much more likely that managing a hedge fund has a greater chance of making that kind of money.  That, dear readers, is why blogging is my second choice for a business undertaking.

Entrepreneurs, I’d love to hear your stories.  How you succeeded, how you failed, what you learned?  Has government (federal, state, local) red tape gotten in your way?  Have you found ways to succeed in spite of all that?

Financial Baseball Brings the Heat

Inquiring minds want to know, how profitable is Major League Baseball?  Well, the inside baseball says “very profitable”.  This after a surreptitious release of Pittsburgh Pirates’ confidential financial documents.  Which makes me wonder, how did the LA Dodgers drop the big money ball?

Well, in the business of baseball, it appears that its all about winning the mighty dollar.  I’m actually impressed.  Major League Baseball is, after all, a business and the cliche “business is business” applies.

One parting thought:  What would baseball be like if there was a baseball team owned like the Green Bay Packers?

Financial Baseball and the Finance of Baseball

If I was asked to investigate buying a (Major League) baseball team, I’d start by building a mental model of the finance of baseball.  I’d start by observing that a team consists of 1) a roster of players, 2) an collection of player contract and player and pick options, 3) a management and coaching team, 4) a stadium and stadium support staff, 5) league contracts and obligations,  6) marketing, television, and media rights and contracts, 7) financial assets and liabilities,(8) ball park ticket and concessions sales.   Well, that’s a start anyhow.

I’d then consider the competitive environment.  It consists of other ball clubs and is played about half of the time on other ball fields.  Naturally AL vs NL is an important consideration.   Generally, wins lead to more revenue, and better (more expensive) players contribute to more wins.  However, that is not always the case.

A baseball team aptly called a baseball franchise.  It exists as a privately owned piece of a larger governing organization.    That larger organization makes all sorts of rules that effect everything from the buying and selling of franchises to the “luxury tax” paid by high-payroll teams such as the Yankees.

I’d love to get my hands on a MLB franchise’s income statements and balance sheet, say for the Chicago Cubs.  I wonder if they made or lost money in the last decade?  I’d be curious to see what correlation there was between their revenue and their win/loss record for each season.  I’d wager that the Chicago Cub’s win/loss-to-revenue correlation is much less than that of most other MLB teams… simply because the Cubs fan base is more forgiving of (or simply more used to) losing.

So, an MLB baseball team is a privately-held franchise of the larger MLB organization.  Similar to a McDonald’s franchise being part of the the larger McDonald’s Corporation.  A key difference being that MCD is publicly traded whereas MLB is not.  (And, of course, a baseball franchise is way more expensive that a McDonald’s franchise.)

Switching gears, consider the derivatives market surrounding baseball (and other sports).  I’m referring to sports betting.    In Nevada alone, sports betting exceeds 2 billion dollars per year.  Many sports bets are analogous to binary options… they either pay nothing or 2X (less the vig) depending on the outcome of a game (and the point spread).