Ten Things Investors Can Learn From the Horse Track

“We look for a horse with one chance in two of winning which pays you three to one” – Charlie Munger

Michael Mauboussin, one of the sharpest thinkers in finance once said, “Crist on Value is one of the best 13 pages on investing I have ever read.” I couldn’t agree more, it’s fantastic. The essay is all about how bettors think and behave at the race track. The parallels between horses and securities are so similar that you could replace horse with a stock and it would read just the same. The essay is most applicable to value investors, but it really is must read for investors of all stripes.

Analysis is only half the battle. Investors don’t pay enough attention to execution.

In fact, if you handicap well and bet poorly, you’ve failed. It’s as useless as crushing your tee shots while three-putting every green.

Mauboussin said “fundamentals are how fast the horse runs and expectations are the odds.” This is where that motivation came from:

Horses that everyone perceives as having a 70 percent chance of winning pay substantially less than $4 because the odds are determined by the amount of money actually bet on each horse.

Investors pay too much attention to glamour and too little attention to value.

Even a horse with a very high likelihood of winning can be either a very good or a very bad bet, and the difference between the two is determined by only one thing: the odds.

Do you invest in compelling stories and hope for the best on price?

Value= Probability x Price

This equation applies to every type of horse and bet you will ever make. A horse with a 50 percent probability of victory is a good bet at better than even money (also known as an overlay) and a bad bet at less (a.k.a. an underlay)…..Now ask yourself honestly: Do you really think this way when you’re handicapping? Or do you find horses you “like” and hope for the best on price? Most honest players will admit they follow the latter path.

Investors tend to ask the wrong question.

Find the winner, then bet. Know your horses and the money will take care of itself. Stare at the past performances long enough and the winner will jump off the page. The problem is that we’re asking the wrong question. The issue is not which horse in the race is the most likely winner, but which horse or horses are offering odds that exceed their actual chances of victory.

There is always the temptation to abandon your strategy when it’s out of favor.

If you begin espousing this approach, you are sure to suffer abuse from your fellow horseplayers. When one of them asks you who you like in a race and you say, “I think the 4 is a bigger price than he should be,” the likely response is, “So what? Who do you like?” Your cronies are apt to tell you that you should be betting on horses, not on prices, and after an inevitable stretch of watching some of their underlays win, you will begin to doubt yourself.

Know your competition.

If every horseplayer but you were a certifiable idiot, betting at random on names and colors, you would win every day. Conversely, if the only people betting into the pool were the small number of professionals who make a living this way, your chances for long-term victory would be slim.

Has investing become too competitive? Yes.

There has been much carping in recent years that the game has become much tougher, or even “too tough.” The game almost surely was easier 50 years ago when takeout was lower and track attendance was much higher, due primarily to racing’s near-monopoly on legalized gambling. Unfortunately, the hordes of fabled two-dollar bettors of that era have mostly been seduced away by the jackpots of state lotteries and slot machines, and the industry has raised takeout to compensate for lost business.

And no.

Does that mean today’s player faces nothing but higher vigorish and the remaining sharpies? Not at all. I firmly believe that, in general, the nitwits still outnumber the sharpies. More important, most sharpies aren’t as sharp as they think, and even the winning sharpies make plenty of egregious mistakes on individual races. As long as the volume of ill-informed money exceeds the takeout, there can be a positive expectation for the true sharpshooter who waits for the competition to make mistakes.

There has never been a better time to be an investor, at the track or in the market.

Despite facing higher takeout and fewer casual opponents, the 21st-century horseplayer has a tremendous opportunity that his counterpart of 50 years ago did not enjoy: The ability to bet a race in a dizzying array of options beyond win, place, and show. Nearly every race in America now offers both multi-horse bets-the exacta, trifecta, and superfecta-and also is part of at least one multi-race bet-a daily double, pick three, four, or six.


Crist On Value

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