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Smart Money IQ: Investing in Fantasy Football – the Market for Studs & Duds

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The world is full of random variables. The rolls of dice are random variables. The returns of stocks are random variables. And, as I’ve been reminded all too well this fall, the stats of football players are random variables.

To be the smart money is to be better than the competition at understanding the likelihoods of possible outcomes and translating that information into the best strategy.

For example, let’s say I’m playing a dice game with someone who thinks even numbers are twice as likely to hit as odd numbers. I, on the other hand, know that each number, one through six, has a one-in-six shot of occurring. I would have a tremendous edge on my competition. I am the smart money. He is the dumb money. (Unless, of course, he chose the dice!)

Warren Buffett is smart money. He has superhuman investing skills. One of those skills is to be better than the competition at forecasting future business performance and translating that to a price the company’s stock should be worth today.

Importantly, he refuses to overpay, often waiting for the market to offer him a bargain at 70 or 80 cents on the dollar. He makes money buying great companies at cheap or fair prices.

This skill applies directly into fantasy football. Pick a kicker in the first-round, and you are dramatically overpaying. This wastes a scarce resource (an early draft pick) on someone you could have acquired much more cheaply (e.g. with your last draft pick), and it keeps you from paying a fair price for an elite running back or receiver.

This is an extreme example, but the lines between overpaying and underpaying, for an investor or a fantasy football manager, can become quite blurred. The smart money sees those lines clearly long after the dumb money’s eyes have gone crossed.

There are four major categories of fantasy football players, and they relate to four types of companies in which you can invest. These categories are based on ceilings and floors. Ceilings refer to upside potential, and floors refer to the worst-case scenario. We want each to be as high as possible.

The categories are:

  1. Studs: high ceilings and high floors
  2. Safety Blankets: low ceilings and high floors
  3. Lottos: high ceilings and low floors
  4. Duds: low ceilings and low floors

We’ll start with the studs. Studs are what you’re after. These guys can, and typically do, perform the best, and they offer a worst-case scenario that is still not that bad. In 2018 drafts, these were guys like Todd Gurley, Ezekiele Elliott, and Saquan Barkley. Older fantasy footballers will remember LaDainian Tomlinson, Marshall Faulk, and Emmitt Smith. As the graph below shows, these players outperform the average fantasy running back even on their worst days.

This graph represents weekly fantasy football point totals for the first six weeks of the 2018 NFL season. The top 40 running back average excludes Todd Gurley, Saquon Barkley, and Ezekiel Elliot. All point values referenced in this article are based on a generous scoring system relative to the standard.

In corporate America, J.P. Morgan is both the most profitable (high ceiling) and the safest (high floor) among the big six U.S. banks, and that is why investors are willing to pay more for every dollar of assets J.P. Morgan owns than for the assets owned by Bank of America.

Quarter after quarter, year after year, Google, Apple, and McDonald’s are going to earn profits for their shareholders that most other companies can only dream of. That’s why these companies’ shares sell for higher multiples, and that’s why Gurley, Elliot and Barkley sell for the first-round premium.

This graph reports the price-to-book ratio (price per share divided by book value per share) on 10/18/2018 for the big six U.S. banks: J.P. Morgan (JPM), Citigroup (C), Bank of America (BAC), Wells Fargo (WFC), Goldman Sachs (GS) and Morgan Stanley (MS). Image via: author. Data via: Yahoo!Finance.

The next category is the safety blankets. These guys are like investing in savings bonds or Wal-Mart. They steadily turn out adequate, but unremarkable performances and derive all their appeal from their stability. Gone are the days where they will surprise you with spectacular earnings growth. In fantasy football, these tend to be older players whose best days are behind them but are central enough to their team’s offense to limit the downside.

The ageless Frank Gore has been the poster child for this archetype. This year, David Johnson best personifies the safety blanket, scoring between 16 and 24 points in all but one of this season’s games.

The problem is, he was drafted as if he were a stud that would score 50% more per week than he currently is. The market was overly optimistic about his 2018 performance, and those that overpaid are suffering low returns on that investment (at least to this point).

The most frustrating, or satisfying, category is the lottos. They can make you feel like a genius or an idiot. These are the guys that could have a breakout year or be completely irrelevant.

A recent example is the perma-stoned and ultra-talented Josh Gordon. He has the potential to be a top-tier wide receiver, as he was during his remarkable 2013 campaign, but he also has the potential to miss games (or entire seasons) due to his tendency to smoke the wrong plants.

More often, lottos are young players that show flashes of brilliance but have yet to sustain such brilliance for long stretches. Similarly, young companies with innovative technologies may or may not turn into world-beaters. For every Amazon.com, there were a thousand “Pets.com”s.

This chart graphs the share price of pets.com from its IPO in February 2000 to its liquidation in November of the same year. Image via: money.cnn.com.

One winning ticket can pay for a ton of misses, but how much of your resources do you want to commit? Random selection is a bad strategy, and “informed” traders run the risk of thinking they’re the smart money when they’re really the dumb money. If you can’t spot the sucker at the table, look in the mirror…it’s you.

The last category doesn’t need much discussion. These are the duds, providing low ceilings and low floors. Avoid them. They have no place in your fantasy lineup or Charles Schwab account (except maybe as a short, but that’s for another article).

As the fantasy football draft progresses, the players chosen will move through the spectrum from studs to safety blankets to lottos, and yes, maybe even a few duds. A bargain in the 7th round can provide greater returns on investment than overpaying in the 2nd round even if the 2nd round player performs better (remember, you paid more for the second rounder, which reduces investment returns).

In markets, the higher prices paid for the Google’s and Apple’s should largely offset their performance advantage over cheaper competitors. Of course, the market doesn’t always get this right, and it offers untold fortunes and championship trophies for those that consistently identify its mistakes.