By Robert Seawright, Proprietor, Above the Market
Bill Barnwell’s excellent article in Grantland today examining whether NFL teams have any idea what they’re doing at the annual NFL draft is both interesting and instructive with respect to how we make investment decisions. Beforehand, a choice between Peyton Manning and Ryan Leaf will seem daunting and easy to screw up while, obviously, the consequences of choices like that are enormous. As Kevin Meers’s research on the NFL draft shows and as Barnwell points out, the average value produced by a player from a given round drops with each passing set of selections. In other words, even though really good GMs can and do make big mistakes, NFL teams generally do a pretty good job figuring out the difference between — say — a second and a fourth round pick. But they have a much harder time distinguishing between second round picks, especially when they play the same position. Barnwell proposes that “the margin of error in analyzing those players is larger than any advantage a particular franchise has in scouting talent.”
Barnwell’s hypothesis is consistent with what others have decided. Wharton’s Cade Massey published a study suggesting that there’s no real difference in the drafting ability of teams based upon longer-term outcomes and accounting for the expectations of the picks they have. Chase Stuart of Football Perspective wrote a piece on Monday that found virtually no relationship from year to year in a team’s ability to produce drafts that would exceed expectations.
The bottom line here is that there are simply too many variables involved in making these decisions to expect any GM to be right all the time or anything close to it. The available information is too limited and too often in error.
Because there is no way to get it right nearly often enough, the best advice is that laid out by Massey in his study: Give yourself as many chances as possible to get it right. In other words, collect as many draft picks as possible — and especially high picks because it’s easier to get things right at the top of the draft than later on (even though the consequences of failure there are much higher — just ask Bobby Beathard).
The investment process is surprisingly similar. While some investors are better than others and only a relative few are truly outstanding (consistent with the NFL talent evaluation pool), the best approach is to give yourself as many chances as you can to get it right.
I’m not just talking about asset class diversification. An investor should select the criteria deemed most important (perhaps P/E or price-to-book, for example) within each desired asset class and then select a significant number of investments within that class which have the appropriate characteristics. Only a true maestro should go after just the “best available” stock (and perhaps even the maestro shouldn’t). The rest of us should focus on a healthy number of stocks that offer the characteristics we think are the best.
We all would like to buy the next great stock at the bottom in huge size and ride it all the way to the top. But there isn’t any evidence that doing so is at all likely. The better approach I propose — in effect owning a whole lot of “first round draft choices — means that you will be far more likely to get the benefits of a “Peyton Manning” stock while the damage from an occaisional ”Ryan Leaf” won’t hurt nearly as much.
Did you have a comment or question about this post, finance, economics or your love life? Feel free to use the discussion forum here to continue the discussion.*
*We take no responsibility for bad relationship advice.