Some call it the best business book out there. Michael Lewis is the author of the best-sellingMoneyball, a look into the roaring recent success of the Oakland A's baseball team gained through their contrary thinking and unconventional means. Tom Gardner found the lessons from Lewis' book quite applicable to general stock investing and very relevant in his search for undiscovered, unloved, and undervalued small-capHidden Gems. And since this is World Series week, we think it's a great time to share this with you. This is the fourth of five parts. Play ball!
Tom Gardner: Michael, do you think the Oakland A's, using the Bill James mentality, are more focused on productivity that is unknown or on valuation that is mis-assessed?
Michael Lewis: Well, the two are related. The reason you get misvalued is that people don't see what your productivity is. But I'd say if you ask Oakland's management what they were doing, they'd say, "We are value investors. What we are doing is finding value where other people don't see it." That is what they would have told you, especially two or three years ago. However, things are changing a bit.
The market in baseball players is actually getting more sophisticated pretty rapidly and so now what they are doing, they are almost short-term arbitrageurs. They are seeing that the market jumps around and the opportunities aren't as big as they once were. There are smaller opportunities that they have to fight to exploit. It feels like they are less Warren Buffett today and more John Meriwether. They're looking for a short-term mispricing of left-handed relievers or a short-term mispricing of outfield defense. That kind of stuff.
Tom Gardner: Is it possible that your book has now done more to help the big-market baseball teams catch up, because there will be a regression to the mean as teams emulate Oakland and spend a ton of money doing so? Or do you think the philosophy is still outrageous enough that all these little opportunities are going to continue to pop up for people sitting with laptops in the front office?
Michael Lewis: I think both. I think that my book made life harder for the Oakland A's of the world and easier for others. The Boston Red Sox were already emulating the A's and they are a large-market team. You can see how tough it will get for Oakland. The book has made the market a bit more efficient and so it's harder for teams who, out of economic necessity, have to live off of market inefficiency.
But remember, the market is always moving. So, for example, the market for on-base percentage has gotten a lot more efficient in the last couple of years. You can't go and buy it cheaply like you used to be able to. But don't forget that the game is still so hidebound that it doesn't move as fast; it doesn't move nearly as fast as Wall Street does. The market moves faster than its conventional buyers and sellers do. Now, if I had written this book on Wall Street and there was a money manager that was doing things that other people didn't understand and I explained it, all of the advantage would have been quickly sucked out of what he was doing. But baseball has less of an interest in being efficient than Wall Street does.
Tom Gardner: Let me play devil's advocate. I do think the stock market tends toward efficiency, but are you familiar with Warren Buffett's speech at Columbia back in the early '80s entitled "The Superinvestors of Graham-and-Doddsville"?
Michael Lewis: Yes, I've read it.
Tom Gardner: So, Buffett basically says these value principles have been out there and yet people ignore or reject them or aren't patient enough to employ them. They don't understand that methodically buying cheap stocks -- in Buffett's case that was Coca-Cola (NYSE: KO ) , American Express (NYSE: AXP ) , Disney (NYSE: DIS ) , and Washington Post Co. (NYSE: WPO ) , among others -- and holding them for long periods of time puts you in the area of probability for superior returns.
Michael Lewis: I don't know. Who am I to say Warren Buffett is wrong? Yes, I've said it before, but he may be right. He may be right. I haven't spent as much time in the stock market as I have in the market for baseball players. I was a bond guy at Salomon Brothers. This is not something that I've spent a whole lot of time thinking about.
But, on the other hand, to play devil's advocate to the devil's advocate, just because Warren Buffett believes it's true doesn't mean it is true. What is true is that if you take the efficient market theorist's view of things, he would say that even if the market is entirely random, it would generate its Warren Buffetts. If you take a thousand people in a coin-flipping contest, in the end you have a winner.
Tom Gardner: Except not so many from Benjamin Graham's classroom!
Michael Lewis: Yes, but I go back to what I was saying earlier. I think that, at this point in Warren Buffett's career, if there are opportunities to be had from his approach, it would be had from finding his mistakes.
Tom Gardner: Well, I believe he's hampered by the amount of money that he has to invest. He's forced to be in much larger companies than the rest of us. So when he says the market looks overvalued, and that investors will get low returns, and that he can find no opportunities now... we have to factor in that he is having to allocate a fortune... tens or hundreds of millions of dollars... where most of the rest of us have thousands or tens of thousands of dollars to allocate. The market for investments in very large entities may be overvalued for Mr. Buffett... while the market for very small entities may still have loads of opportunity in it.
Michael Lewis: That is right, so he can't invest in the things where there is hidden value because they are too small for him.
Tom Gardner: He has said as much. That's a limitation for him. Yet I still think the stock market for long-term value investors offers substantial pricing inefficiencies. Michael, how much new analysis do you think there is to be carried out in baseball and maybe by extension the stock market? Are there new Bill James discoveries out there? Will there always be? Or have the most significant ones already been discovered?
Michael Lewis: Well, James would tell you they've just scratched the surface and that there is a great deal more to learn. I would say that they've done more than scratch the surface and that a lot of the big things are understood.
But, having said that, the single biggest opportunity for someone running a baseball team is that black hole of misunderstanding surrounding amateur baseball players. If you can go out and find the guys who are in college or in high school who will be successful major league baseball players, you will have a dynasty like none that's ever been seen before because of the way baseball is structured. You will own all of the best players for the first six years of their big league careers. Yet nobody has figured out how to do it. This is the biggest opportunity out there. It's the mother of all inefficiencies in baseball.
And not only has nobody figured it out, but the process of trying to answer that question is only just beginning. And it's not being addressed with the kind of verve and enthusiasm that you'd think it would be addressed, given the stakes. The A's are doing a bit of research about it. The Blue Jays, the Red Sox, the Dodgers all are doing their own. They all have their own little research projects, but they are very little.
If you gave me $20 million and a couple of years and I got lucky in who I hired to conduct the studies, I bet I could find things out about the minor leagues that would be extremely valuable to baseball teams. So there are still huge opportunities, and that's probably true in stock investing, too.
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