I recently read the transcript of a speech by Daily Racing Form publisher Steven Crist that was given at a forum held by mutual fund company Legg Mason (NYSE: LM). Crist drew many parallels between successful strategies in betting on horse racing and successful strategies in investing.
Stop trying to be smarter than the average bear
Crist summarizes the point thusly: "Most horse players spend their lives thinking that if they just studied a little bit harder or got a little bit smarter, they could pick the winner of the race enough to make some money."
Sometimes, it's easy to get caught up in this game and spend an enormous amount of time and capital trying to figure out which technology company will become the next big winner. I spent many years, and a lot of money, trying to figure out whether Drugstore.com (Nasdaq: DSCM) would become the next Amazon (Nasdaq: AMZN) or Walgreen (NYSE: WAG). After years of trying, my time and capital went to waste, as Drugstore.com failed to live up to those lofty benchmarks.
The solution to this problem is to simply stop doing it. I've come to realize that I don't have a crystal ball that's clearer than my fellow investor's. Instead, successful investing doesn't require predictive powers, but instead patience, diligence, and courage.
Instead of trying to predict, look for mispricings
"What you really want to do is determine which most-likely winners are good prices and which most-likely winners are bad prices," Crist says.
Interestingly, this statement can be interpreted very similarly to Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B) Chairman Warren Buffett's advice to buy great businesses at fair prices.
Crist advises investors to wait until the public makes a mistake, just as value investors patiently wait until the stock market makes a mistake. Once a great business goes on sale, savvy investors make big bets when the odds are heavily in their favor. For example, during the banking crisis of the early 1990s, Buffett bet big on Wells Fargo (NYSE: WFC), one of the most respected banks in the world, when other investors sold the stock as if it were going out of business.
Learn why mispricings occur
Crist describes a variety of mispricings. For example, he's noticed that because fans across the nation idolize the Dallas Cowboys, and blindly place bets accordingly, smart bettors can take advantage of the crowd's mistakes. Similarly, investors should stay away from stocks that have become so idolized that their prices far exceed their true values.
Crist also advises bettors to look for inefficiencies, noting that there are probably more opportunities in college betting versus professional. This is because there are many more college teams and less access to information, allowing an informed bettor a greater edge.
Similarly, investors in small-cap, foreign, or obscure special situations can find informational edges more easily than in megacap stocks, where they'd have to compete against squadrons of analysts and institutional investors.
Foolish thoughts
Crist provides a lot of food for thought. Oftentimes, it seems having the wrong approach to investing can be a big detriment to long-term success. A more successful approach might be to look at investing as probabilistic bets on individual companies: The focus should be on finding where the stock market vastly underestimates a company's probability of winning.
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