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What can horse racing teach us about value investing?
This was the topic we discussed in our latest Money Concepts episode.
Here's the full ~1.5 hour recording. If that seems too long, scroll down for some key insights and short highlights!
Link: callin.com/link/iOmfhLZitI
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Steven Crist is highly skilled at betting onvv and profiting from horse races.
He's written a book chapter -- Crist On Value. It's 13 pages long.
Prof. Michael Mauboussin (@mjmauboussin), whom I greatly admire, has called this "the best 13 pages on value investing".
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You can get this book chapter (for free, as a PDF) here:
Link: hvst.com/posts/value-an…
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To fully appreciate the insights in this chapter, you need to know a little bit about:
- Probability,
- Horse Racing, and
- Expectations Investing.
In this thread, I'll help you understand some of these fundamental concepts.
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Key Insight #1
We should learn the distinction between Investing and Speculation/Gambling.
*Investing* is all about:
- Doing the work,
- Spotting mis-priced opportunities -- ie, discrepancies between *price* and *value*, and
- Intelligently betting on these opportunities.
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Here's a section from Buffett's 2013 letter that I found very useful in understanding the distinction between *Investing* and *Speculation/Gambling*:
As usual, Buffett's articulation is clear and spot on:
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This "value investing" philosophy can be practiced in many places -- in financial markets, at the horse races, at poker and blackjack tables, in sports betting, etc.
And "investors" from all these different disciplines can learn from one another:
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Key Insight #2
As investors, we should strive to master the basics of probability.
No investment is a 100% guarantee.
Whenever we buy a stock, we are making a probabilistic bet.
Our portfolio is a collection of such bets.
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Thus, understanding the fundamentals of probability can help us manage our portfolios for the long term without taking undue risk.
Plus, probability is such a delightful subject to learn -- just for its own sake!
(h/t @jposhaughnessy)
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So, how exactly do we go about learning probability?
I suggest a 2-step process.
Step 1. Read non-technical books (like those by @nntaleb and @AnnieDuke) to get acquainted with the big key ideas -- conditional probability, survival, base rates, etc.
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And Step 2: Take a probability textbook (or a book of probability puzzles) and work through all the examples and exercise problems in it.
This will concretize our understanding of the ideas from Step 1, and improve our numerical fluency in applying them.
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Key Insight #3
Expectations Investing
Whether we're betting on stocks or horses, we're participating in a kind of "parimutuel" system.
In such situations, out-sized profits come NOT from finding *winners*, but from finding *mis-priced bets*.
(h/t @mjmauboussin)
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An example of how "Expectations Investing" may play out in practice, in the stock market:
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And here's Steven Crist, outlining how Expectations Investing plays a very similar role in horse races as well:
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Key Insight #4
Investors should seek to minimize overheads as much as possible.
In a horse race, this may be the racetrack's "takeout".
In financial markets, this may be transaction costs, advisor fees, capital gains taxes, loss of purchasing power due to inflation, etc.
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Key Insight #5
Sometimes, "exotic" bets may be more mis-priced than "ordinary" bets.
With horses, this may be an exacta/trifecta.
With stocks, it may be a pairs trade/options strategy.
We shouldn't disregard a bet just because it looks complicated. It may be lucrative.
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Key Insight #6
While porting over lessons from one discipline and applying them to another, it's important to be conscious of fundamental differences between the two disciplines.
For example, *horse racing* may be a *negative* sum game ...
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Whereas *investing in stocks* may be *positive* sum (at least, for long-term investors).
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About Money Concepts
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