Favorites or the field?

The top five S&P companies account for 22% of the index’s earnings and a similar percent of the market cap.

“To me that is an interesting market question right now. If you were a betting man would you take the other 495? Would you take the field or would you take the Lakers with LeBron, a healthy Anthony Davis, James Harden and Kevin Durant on the team too?” – Carl Kawaja, Invest Like the Best, July 2021

One way to improve decision making is to understand the mechanics of a system. The physics system for example is relatively stable and that’s why, with great work, engineers can land the Perseverance rover in a Martian area twice as wide and one-third as long as Manhattan. Other systems, like social systems, follow the rules of network effects like the friendship paradox.

Sometimes analogies help to understand the type of system. One sporting analogy is to take the favorites or the field. When Kawaja’s episode was released, the Chiefs and Bucs had a cumulative 33% chance to win the NFL big game. Sports vary though. In January 2020, three NFL favorites had cumulative odds of about 30%. Meanwhile the top three NCAAF football favorites had odds of about 75%. Three tennis players at the French Open get a bettor to better than ninety-five percent. Want to bet the PGA Master favorites? The top seven golfers only get you better than a coin flip.

Odds in January 2020

One reason to take the field is that more can go wrong than go right. Something is always happening and it’s more likely to be a “negative tail” event than a positive one. During the 2020-21 NFL season we guessed that Tom Brady would not hit the over on passing yards (he did) by guessing that injury, Covid, and new teammates had a much larger downside area. Kawaja recognizes this too, noting “guys get injured”.

It’s not that the field or the favorite is better, but which is cheaper relative to the expected returns. During the Big Game for instance, things happening (safety, two-point conversation, etc.) are priced higher because people like to bet more on something happening. Successful betting and investing isn’t about finding the best, but finding the best odds. Yes, the Chiefs and Apple are great teams but is there value in the high prices?

Physics systems or social systems are wonderfully illuminated in Nassim Taleb’s book Antifragile.

What you pay: Deals in the NBA

Shane Jensen to Seth Partnow, “you make the decision to be agnostic to contract in your analysis, but as you think about building a team, contracts are something you need to take into account.” Partnow notes:

“If you’re doing an asset value ranking then age and contract come into the decision making process. There’s some players at the very high end you pay whatever: LeBron, Kawhi, Giannis. You pay them whatever because they still outperform that based on the max contract structure. It’s almost literally impossible to overpay those players.


The other group that tends to outperform their contract is rookies, again based on contract structures.

This was in the same podcast where the Wharton hosts discussed Tom Brady, who is making more things go right, and appears to be defying the Howard Marks word of warning: “Buying good things can’t be the secret to success in investing. It has to be the price you pay. It’s not what you buy, it’s what you pay. There’s no asset so good it can’t become overpriced.”