A $1 Billion Opportunity: NCAA Brackets as Investments

March Madness is in full bloom. Stoking the madness is an alluring incentive: Quicken Loans (with the help of Warren Buffett and Berkshire Hathawaywill award $1 billion to anyone who can get a perfect bracket. Though it's unlikely that anyone will actually win the grand prize, top finalists will win $100,000 each (not a bad payday for a free bet). So can we improve our chances of winning?

Since we talk about stocks and investing so much, let's use that knowledge to give ourselves an edge in bracket-picking. I wrote this article because the skills we use to pick stocks and create portfolios are directly applicable to picking brackets. Plus, it's fun to talk brackets.

Where is there value?

We all know that there is a big difference between perception and reality. What a stock (or team) trades for (what its seeded) can vary drastically from its true value. For this portion of your analysis, take a look at leading websites, like sagarin.com or kenpom.com, to get a ranked listing of the teams based on their statistical value -- it's the closest thing we can get to "valuation" for this practice.

If you see a 4 seed ranked 41st in the country, then maybe you shouldn't think of it as a "4 seed" in your brackets. There's a chance it'll only be in the tournament for a "short" amount of time. Likewise, if you see Louisville as a 4 seed, yet they are ranked in the top 5 overall, it could be time to take them "long" into the final four.

What is the market pricing in?

In the first round, it's typical for eight to 12 upsets to occur. How do you pick the right ones? First, skip Weber State and Coastal Carolina. It's fun to swing for the fences and be the person to call it, but it's not happening -- a 16-seed has never beaten a 1-seed, and it won't happen this year either.

In order to properly find upsets, put your "trader hats" on and ask: What is the market pricing in?

For this, we will look at what market participants (bettors) are pricing in (through betting lines, or what investors would call "quotes") for each game:

8 seed vs 9 seed

Team (seed)

Spread
(team on left favored)

Team

Pittsburgh (9)

-6.5

Colorado (8)

Oklahoma State (9)

-1

Gonzaga (8)

Memphis (8)

-2.5

George Washington (9)

Kentucky (8)

-4

Kansas State (9)

     

7 seed vs 10 seed

Team

Spread
(team on left favored)

Team

Texas (7)

-2.5

Arizona State (10)

UConn (7)

-4

St. Joseph's (10)

New Mexico (7)

-2

Stanford (10)

Oregon (7)

-2

BYU (10)

"The market" is pricing in that two 9-seeds will win their games, while also pricing in that it's less likely Kentucky loses its first-round game than higher-seeded Oregon. I like to look at this analysis to get a feel for "market participant perception," just as I would if I were trading.

I think the best way to use this strategy is relative to other games on the same line (like comparing all 7 vs. 10 games against each other, just like comparing metrics on similar companies).

When in doubt, pick teams that have done a good job lowering transportation costs

If it's still too close to call, take the team that's closer to home. There's a better chance their fans show up, the effects of time zone changes (if any) or lower, and it's easier to focus on the game, which could result in a better performance. Good luck to any team that has to play Syracuse in Buffalo, or Duke in Raleigh, N.C.

Don't fall in love with a stock (or a team)

Do you have that one stock in your portfolio that's never really made you money, but you don't want to sell it because you've convinced yourself that you're in it for the long haul? Chances are picking your bracket in the same manner will result in equal dissatisfaction. Maybe it's your alma mater, maybe you watched them as kid, or maybe "Pounce the Panther" out of Milwaukee is the coolest thing you have ever seen; BUT DON'T PICK THEM!

This is $1 billion we're talking about! Look at the data, form a thesis, and make the right selections. Pounce the Panther will forgive you.

It's OK to hold onto one flyer (but only for a while)

This might sound like a contradiction, but it's OK to hold onto one long shot into the sweet 16. Usually, at least one double-digit seed makes the second weekend. Again, it's not Pounce the Panther, but a team in the 10 to 13 seed range making the sweet 16 is realistic. Some names I think have a higher likelihood include:

(11) Providence

(11) Iowa/Tennessee

(12) North Dakota State or (13) New Mexico State

Odds say that the second weekend is the last weekend for these teams, so let's take our gains in the sweet 16 and not advance them any further.

So overall, we'll let one speculative pick slide because the odds say it makes sense. Plus, it's fun to root for the underdog -- we'll call it our own personal Plug Power!

Trust in good management teams

Just like investing in companies, teams should be given a premium valuation if they have strong management teams, or in this case very successful coaches. Teams like Michigan State, Louisville, Duke, Syracuse, Florida, and Kansas should be given a little extra value when filling out your bracket because they have experienced coaches who have won championships. When it comes down to the final minutes of the game,  you want teams that are in trusted hands of coaches with long histories of strong execution.

Make sure 'blue chip' teams are weighted more heavily in your bracket

Just like when you construct a good portfolio in order to minimize risks, make sure that your final four is weighted more toward the top teams. It's fine to have a bunch of small positions (early round wins) in speculative teams, but make sure that your core portfolio (the big games) holds top 10 teams. Here's the top 10 list from Kenpom.com, a leader in statistical analysis on college basketball:

1

Arizona

2

Louisville

3

Florida

4

Virginia

5

Wichita State

6

Villanova

7

Duke

8

Creighton

9

Kansas

10

Michigan State

As tempting as it is to include the Ivy League in all the fun, I plan to have all of my final four picks come from the list above.

Risks for this bracket strategy

1. There are no risks, it's free!

OK, well if you want some risks (because we have to always ask ourselves "what's the downside")...

1. You could lose your job because you spend the next 8 hours working on your bracket, and maybe your boss isn't a basketball fan

2. You could be reading this article, thus missing out on another article that could be making you money in the markets.

3. I could be totally wrong and Pounce the Panther could be hoisting the trophy on April 6. That's the fun part about March Madness: Anything can happen!

Conclusion

Overall, this is just a fun exercise on how to use your investing skills in other areas -- I hope that some of the information above helps you fill out your brackets better. I wish everyone the best of luck in March Madness! (Except, with apologies because I'm a big fan, Warren Buffett.)

One big winner

Like the gap between Florida and Weber State, there's a huge difference between a good stock and a stock that can make you rich. The Motley Fool's chief investment officer has selected his No. 1 stock for 2014, and it's one of those stocks that could make you rich. You can find out which stock it is in the special free report "The Motley Fool's Top Stock for 2014." Just click here to access the report and find out the name of this under-the-radar company.


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