With the ‘Dog Days of Summer’ in the rear-view mirror and autumn fast approaching, many are resisting the thought of cooler weather to come. However, the baseball fan in me looks forward to the fall as pennant races come to fruition and the World Series begins. I grew up playing baseball and continue to do so as a hobby today. Perhaps it isn’t surprising then that I find myself in a career as an investor given many of the parallels that exist between the two activities. At their essences, both baseball and investing are exercises in failure. The best hitters in Major League Baseball have a .300 batting average – meaning for every ten at-bats, the best at their craft only get a hit three times. Stated differently, the “best” in the game can expect to fail (i.e., not get a hit) 70% of the time! Similarly, no investor can expect to ‘get a hit’ (i.e., see an investment thesis work out) 100% of the time. There are simply unforeseen circumstances and emerging new information that can alter even the best investment theses.
Another way that both baseball and investing are alike is that they are heavily process driven, if performed successfully. In the 1997 Berkshire Hathaway Letter to Shareholders, Warren Buffett highlights the discipline of Ted Williams and how his approach to hitting is applicable to investing. The Boston Red Sox legend, Williams, literally wrote the book on hitting a baseball (The Science of Hitting), but he’s more known for having one of the highest career batting averages at .344. A summary of Williams’ process was he divided the strike zone into 77 different sections, each the size of a baseball. He studied his batting average, or chance of success, for each section. Williams used the subsequent knowledge, combined with discipline, to try and only swing at pitches in his personal and optimal strike zone. It sounds simple, but involves strict adherence to the process.
There are parallels to QV’s investment process. The backbone of our investment philosophy is our “Seven Tests” approach to equity investing. Underlying each respective test are numerous areas to analyze; for example, within the Financial Record test, we can assess the record of compounding earnings, evidence of margin stability, and return on equity, or within the Management test, we can assess the team’s alignment and execution on strategy and capability. The Seven Tests approach can create numerous combinations, just as Ted Williams divided the strike zone into numerous sections. Continuing with Williams’ approach, we can assess what mix of the Seven Tests/underlying analysis combine in the right way to be in the ‘optimal’ part of our investing ‘strike zone.’ Said differently, there are combinations of our Seven Tests approach which will produce a margin of safety that allows for the greatest chance of success. We face “pitches” in the form of stocks contemplated for investment. Adhering to the process means swinging at the best pitches that are in the optimal part of our investing strike zone.
Unlike a hitter who only has a split second to decide if the pitch is worthy of a swing, as investors, we don’t have to swing right away. We can assess a business, taking it through our investment process and Seven Tests analysis, and determine that it’s not investible today. We can ‘wait on the pitch’, that is, we build out an inventory of stocks and indicate what needs to change for a possible investment to enter the strategy (or enter the optimal part of the strike zone). We can also simply decide to not swing the bat at all. One fundamental difference in the analogy is that investing is like a “no-called-strikes” game. Ted Williams can decipher his ideal pitch down to 1/77th of the strike zone, but the pitcher can still throw three strikes that are in the sub-optimal part of Williams’ personal strike zone. If Williams doesn’t swing the bat, he will be called out on strikes by the umpire. In investing, there are no called strikes. We can watch as many pitches go by as we please. As Buffett notes, people will be yelling at us to swing the bat (investment ideas pushed from various sources), but if we stay disciplined, ignore the noise, and only swing at our best pitches to hit, we will put the odds of success in our favour.