The annual NFL Draft has become one of America's most widely
anticipated sports-related events, with thousands of people
flocking to New York's Radio City Music Hall last month to witness
the festivities. Millions more watched on TV or followed on the
Internet.
If you were one of the many who watched the live coverage of the
draft, you at times may have felt more like you were watching a
value investing symposium than a sporting event. Terms like "great
value pick", "rising stock", and "too risky at that price" get
bandied about constantly by analysts come Draft time.
It's for good reason -- building an NFL team is in many ways not
all that different from building an investment portfolio. General
managers are continually weighing risk and reward in trying to
value different players, just as good investor weighs risk and
reward in evaluating company and stock. In both cases, they look at
fundamentals (for G.M.s, it's 40-yard dash times, height and
weight, yards-per-carry; for investors, it's things like earnings
growth, return on equity, and debt levels), as well as intangibles
(leadership ability and "character" matter to the G.M.s, while
factors like pricing power and brand recognition matter to
investors).
In both cases, value is also huge. A particular player may be
far too risky a pick to be taken in Round 1, but a bargain if still
on the board in Round 3. Similarly, the stock of a particular
company may be a bad buy at 30 times earnings, but a very good bet
at 8 times earnings. Good G.M.s and investors also must be able to
assess whether short-term problems -- injury, underperformance,
etc. -- are signs of long-term trouble, or mere blips on the radar.
And they must be able to separate hype from reality.
The parallels are more than just interesting; there are lessons
that investors can take from the Draft. The first is that you need
to do your homework -- the best NFL teams spend tremendous
resources on talent evaluation, and analyze Draft prospects from a
myriad of angles. Investors should practice a similar due diligence
before buying stocks, using strategies that put a company and its
stock through a gamut of financial and fundamental tests.
Here are a couple more lessons the Draft can teach
investors:
Great Companies/Players Are Worth a Higher Price:
In a letter to Berkshire Hathaway shareholders, Warren Buffett once
said, "It's far better to buy a wonderful company at a fair price
than a fair company at a wonderful price." The New York Giants must
have been thinking something similar in 2004, when they traded two
first-round picks and a third-round pick for the number one overall
pick, quarterback Eli Manning. It wasn't cheap, but Manning has
proved worth it, leading the Giants to two Super Bowl victories in
the past five seasons.
Right now, my Guru Strategies (each of which is based on the
approach of a different investing great) think discount retailer
The TJX Companies (
TJX
) is a bit like Manning was back in 2004. It's not exactly
dirt-cheap, trading for 21 times trailing 12-month earnings and at
a free cash flow yield of just 2.7%. But it's a wonderful business:
It's increased earnings per share in every year of the past decade,
has about half as much debt as annual earnings, and sports a 47%
return on equity. My Buffett-, Peter Lynch-, and James
O'Shaughnessy-based strategies think the higher-than-average price
tag is worth it for a business like that.
Look Under the Radar:
Injuries, a lack of talent around them, playing for a small school
-- for numerous reasons, good players often fall through the Draft
cracks. A great example is Tom Brady, who was overlooked in part
because he split time during his senior season at Michigan with a
younger, more highly touted quarterback. He fell to the Patriots in
the sixth round of the 2000 Draft. Three Super Bowl titles later,
he's a lock for the Hall of Fame.
Similarly, the market has many strong "sleeper" stocks that may
be too small, unexciting, or blandly named to get the attention of
most investors. Take J2 Global Inc. (
JCOM
). While dozens of analysts follow the big tech firms, only about
seven follow this cloud computer services small-cap, and most
investors probably don't know the company. They should. It has
upped EPS in all but two years of the past decade, has no long-term
debt, and a 16.0% earnings yield, reasons why it gets strong
interest from my Buffett- and Joel Greenblatt-based models.
If You're Going to Take Risks, Do It on the Cheap:
Marshall University running back Ahmad Bradshaw was considered a
top talent heading into the 2007 Draft, but some off-field brushes
with the law made him too risky to be an early-round pick. But when
he fell all the way to the seventh and final round, the New York
Giants snatched him up on the cheap -- and it paid off: Bradshaw
has been a major contributor on two Super Bowl-winning Giants
squads.
My strategies see a similar story in oil giant BP PLC (
BP
). The firm has had a ton of bad press -- deservedly so -- for its
Gulf of Mexico spill, and more potential lawsuit payouts loom. But
its fundamentals are good (39.3% debt/equity ratio; 22% return on
equity; 5.1% dividend yield), and it's dirt cheap, trading for just
4.9 times earnings, 0.3 times sales, and 1.01 times book value. All
of that helps earn it high marks from my Lynch-, David Dreman-, and
O'Shaughnessy-based strategies.
There's one final broader lesson to take from the Draft, though
it has more to do with what happens well after the selections are
made: Give your picks the chance to succeed, but don't get too
emotionally attached to them. Just as the most sure-fire NFL
prospects can fall flat on their faces, so too can the most
solid-looking stocks. Teams must continually re-evaluate players
and be willing to dump failed prospects they once were enamored
with; investors must continually re-evaluate their holdings and be
willing to sell stocks they once adored when their outlooks change.
In both cases it means admitting you were wrong, which is painful.
But holding onto mistakes only makes it more difficult to win over
the long term.
Now you're on the clock. Draft wisely.
I'm long JCOM, TJX, and BP.