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Sport of Stock Betting

Last week I met an old friend, Chuck, for lunch to pay off a long standing sports bet.  The loser of the bet buys lunch for the winner.  Every March we bet on the number of wins that the Seattle Mariners will have in the upcoming season.  One of us picks a number, say 79.5,  while the other picks a number above or below that number.  This is a typical over/under bet that is available in Las Vegas.  This year Chuck selected 79.5 as the number, and I selected the under which means I bet that the Mariners would win 79 or fewer games.  As luck would have it, the Mariners won 87 games this season surpassing my expectations.  My wallet was a bit lighter as a result.

When we started the bet, I won an inordinate amount of the time.  Looking back the reason for this was fairly simple.  Each March I would “research” the Las Vegas sports books online to see what number they were selecting for Mariners’ wins.  I made my bet based on this information.  Chuck, on the other hand, would make his decision based on what he thought the Mariners’ win total would be.  I remembered the words of the late Beano Cook (ESPN college football analyst) “There’s a reason the sharpies in Vegas live in big houses and send their kids to Harvard”.   The Las Vegas odds-makers don’t care about whether the Mariners win total is above or below the number that they set, they just want an equal number of bets on each side of the number.  That way the losers pay off the winners while the odds makers skim off a small percentage of the bet (vig) for brokering the bet.  The odds makers live quite well off of the vig that the betting public willingly pays to make the bets.  To stay in business the odds makers must be very good (and they are) at setting a number that will induce a 50/50 split among the total number of bets.

After a few years of defeats, Chuck wondered how I won an inordinate amount of the time.  I let him in on my strategy.  Since then, he also has “consulted” the Vegas sports books in March.  Both of us use this information, and it has turned our bet into a 50/50 proposition.  In fact, Chuck has won the last two lunches and stated that the law of averages is catching up with me.  He is quite right.  The number or betting line set by the Las Vegas odds makers is nothing more than a reflection of the expectations of all the people (the market) who are betting on the outcome.  This is what a free and highly competitive market is all about.

What does this have to do with investing?  Everything.  For decades academic researchers have demonstrated that the price of a particular asset, traded freely, reflects all of the information that the market participants bring to the market.  In other words the price of any security, at any time, is fairly priced.  If it were otherwise, you would have an imbalance between buyers and sellers.  Why do prices change?  They change because new information comes out.   News is a random or unpredictable event, and it causes market participants to change the price at which they are willing to buy or sell a security.  

There are times when asset prices are “mis-priced”?  Possibly.  Nobel Laureate Robert Schiller believes so.  But even he admits that a person is unlikely to recognize and profit from such “mis-pricing”.  People who try to make money on market “mis-pricing” are speculating, not investing.  Research shows that few people constantly make money speculating on securities.  Like the sports betters in Vegas, how many of them “live in big houses and send their kids to Harvard”?

We know what a speculator is but what is an investor?  An investor is someone who builds a diversified portfolio of stocks and bonds.  He or she selects a balance between stocks and bonds that matches well thought-out goals with a willingness and ability to endure risk.  An investor has learned from the academic research, and typically previous experience as a speculator, that successful financial results come from NOT trying to out-smart the market.  An investor realizes that long-term stock returns come from the earnings growth and dividends from the companies that he or she has in the portfolio, not on “mis-pricing”.   

Sports betting and securities speculating are zero-sum games.  For every winner, there must be a loser (someone who guesses right on new information and someone who guesses wrong on new information).  Since investment returns come from earnings growth and dividends, every investor can be a long-term winner, if only he or she doesn’t speculate.

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