Paul DePodesta and Investing

Last week I saw on ESPN that the Cleveland Browns signed Paul DePodesta—of “Moneyball” fame—to be their Chief Strategy Officer. Whatever that means. As a Baltimore Ravens fan I’m a little worried and you’ll probably see why after reading this. If the Brown’s owner actually lets DePodesta implement his ideas (and that is a BIG if) the AFC North teams will no longer be able to count on two easy wins each year.

History

For those not familiar with DePodesta he’s best known for being Billy Beane’s (Oakland A’s GM) sidekick, which is chronicled in the book “Moneyball” by Michael Lewis. In the movie he is portrayed by Jonah Hill, albeit by a different name because DePodesta didn’t want his name used. Moneyball showed how the use of analytics (sabermetrics) was radically changing player scouting/evaluation in baseball.

**Sidenote: DePodesta started with the Cleveland Indians, moved to the A’s, Dodgers and then Met’s before getting the Brown’s job. He’s dabbled in Finance and Health Care as well.

DePodesta played wide receiver at Harvard, but didn’t get on the field much. While at Harvard he was an intern for Jim Pinkerton (deputy assistant to President George H.W. Bush), where he was told by Pinkerton to go read Thomas Kuhn’s “The Structure of Scientific Revolutions” and not come back until he was done. This led to what became DePodesta’s quasi motto/philosophy: “If we weren’t already doing it this way, do you think this is the way we would do it?.”

What really caught my attention though, was an open letter DePodesta wrote called, “The Genesis, Implementation, and Management of New Systems”.  I was amazed at how many quotes could have just as easily been applied to investing. In fact I wouldn’t be surprised if DePodesta tried his hand at investing and became fairly successful. He is very analytical, focused on long term results, has the right temperament and looks to take advantage of inefficiencies.  Sounds like a value investor to me.  Anyway, below are some quotes from the letter (and some from articles) that I thought were informative.

Quotes

In the letter DePodesta leads off with a quote from Common Sense:

“As an introduction to the second edition of his pamphlet, Common Sense, Thomas Paine wrote, “perhaps the sentiments contained in the following pages, are not yet sufficiently fashionable to procure them general favor; a long habit of not thinking a thing wrong, gives it a superficial appearance of being right and raises at first a formidable outcry in the defense of custom.” Well, welcome to the world of baseball. “

He might of well said “Well, welcome to the world of investing.”

 

On Moneyball:

“Michael Lewis in Money Ball referred to us as crazed K-mart shoppers who would take anything we could fit in our cart in under 15 minutes. I prefer an analogy with Warren Buffett or Charlie Munger. [laughter] Either way it became clear to us that the inefficiency in decision-making in baseball was vast.” 

Basically this guy is a value investor looking for undervalued athletes.  How many sports executives know who Charlie Munger is?  Let alone what his and Buffett’s philosophy is.

Reading and Continuous Learning

 “I always felt those other things [jobs] were informing me and making me a better executive,” DePodesta told VICE Sports this week in his first interview since joining the Browns. “I think a big part of it was being this continuous learning. It’s not necessarily conscious. It’s just the way I am. For 20 years it was, ‘What can I take from this and how can I maybe apply it to baseball and make us better?’  

“In the last 10 days I’ve learned so much and I know how much more I have to learn,” he said. “That’s sort of my mindset, more than anything else, whenever I get into anything new. I’m in this constant pursuit for new knowledge. I think I sometimes focus more on all the things that I don’t know and what I’m trying to figure out.”

“In Oakland, DePodesta and Beane often found ideas outside of baseball. Beane, like DePodesta, is a voracious reader, he said. They would read very little about their own sport and look to outside sources for information and, hopefully, guidance. Sometimes, something would click.”

Reading and continous learning are the backbone of great investors. I read these quotes and felt like I was reading a letter by Buffett, Munger, or Klarman. Don’t get caught up in the analogy though, focus more so on the content of what he said. It’s just good advice.

Bias/Subjectivity

“To the untrained ear, these scouts were unbelievably convincing. Some of their subjective opinions almost sounded like they were objective. If you had worn a major league uniform at some point in your life, you were somehow qualified to make these judgments despite a complete lack of empirical evidence to support your claims. Don’t get me wrong, subjectivity by itself isn’t really a sin, and complete objectivity isn’t perfect either. In our industry we make a lot of educated guesses on the future performance of people under very stressful situations. Subjectivity will be an element in any decision we make.”

“The response to all this questioning was somewhat expected. There were opinions layered on top of opinions. A lot of people were saying, “I think it’s because,” or “maybe it’s this,” or even “that’s the way we’ve always done it.” My industry is comprised of human capital—the players are our assets. So subjectivity plays some role. But the enormity of the subjectivity was staggering. Our scouts even started making up vocabulary like “pitchability” to describe players.”

“The incredible thing is that in subjectivity there are a lot of biases that come into play—emotional opinions or focusing just on outcomes, or even worse, focusing on the most recent outcomes.”

“Opinions are great—don’t get me wrong. They’re great for starting research projects. Then you go study and see if you can prove the opinion or not. But when placing multi—million dollar bets on future outcomes, opinions are wholly unsatisfactory. Opinions as conversation starters are fine. Opinions as conclusions are very bad. I started research projects to discern the objective “why.” I wanted to know why certain teams won and why other teams lost; why certain drafts produced big stars and others didn’t. This was the naïve question at work.” 

“Evaluation is really at the core of decision—making whether the field of endeavor is baseball or picking stocks. It was clear to me that using clearly subjective evaluation was shoddy at best.”

Subjectivity is a necessary part of the investment process, but evaluation and thorough analysis should be first and foremost.  Basically, don’t let ones opinion/subjectivity lead the analysis.  I think we’re all guilty of this one to some degree (myself included).  I see it all the time on CNBC, FinTwit, research reports, etc.  People have a subjective opinion on a stock and make it seem as if it’s objective.  Either they let their opinion shape the analysis or they don’t do any real analysis at all.  And man some of them are really damn convincing.

Even more evident in investing is the intense focus on recent outcomes.  This is Mr.Market at his best and why a longer time horizon paired with good analysis can be a huge advantage.  In my opinion this is my greatest advantage as an investor.

“Evaluation is really at the core of decision-making.” 

I might put that on my wall.  So simple.

Preconceived Notions

“In retrospect, I had a distinct advantage over everybody else in the industry at the time in that I knew absolutely nothing. I’d played baseball in college but that was about it. Because I knew nothing I observed everything critically and took nothing for granted. I spent my first few years with the Indians analyzing all of their systems, from contracts to player development and scouting. Because I had no preconceived notions over how an organization ought to be run, this was an education for me.”

This quote made me think of Buffett’s thoughts on EMH and how students are being taught EMH at universities.  I believe Munger has had similar thoughts/comments as well.  I remember the first time I learned about EMH in school and just shook my head. (thought the same thing with Economics)  It made no sense to me, but to many it was just “this is how I was taught, this is how it’s done.”  Coming into something fresh can be a huge advantage especially if you ask questions and observe critically.

“The problem itself wasn’t the people. Our scouts were very loyal, passionate, industrious people. The problem was the operating system. The industrial inertia was leading them further and further away from the truth.”

This too is true of many analysts, investors, hedge fund managers, etc.  For the most part these guys/girls are all trying to do their job, but various incentives keep them from doing what they are truly supposed to do.  Sell-side analysts are highly capable analytical people that work hard and I’m sure mean well.  As long term investors we often shake our heads when we hear some ridiculously short term focused question asked during a conference call or see a downgrade on a stock because of an issue that has no bearing on the long term success of the company.  Analysts do this not because they’re idiots, but because they’re incentivized to do so (or dis-incentivized to think long term) in their respective system.

Maintaining Success

“How was I supposed to innovate a supposedly smooth running machine? There was, however, a crisis underlying our success. Our lofty expectations had stifled our innovative spirit. Everything we had done to be successful, we stopped doing. We were hanging on instead of trying to move forward. We signed veteran, big name players who everybody knew. Our team got a lot more expensive and started growing older. Though I was seeing all this, I didn’t have much of an audience in Cleveland.” 

Not much to add here.  It reminded me of funds with massive AUM that are no longer able to invest the way that originally made them successful. (style drift?)  Also, when funds are successful many tend to be more conservative in order to keep clients (generate fees), rather than focus on compounding returns.  A successful fund like this might be less likely to give an analyst leeway for creativity and/or have much influence on the portfolio.

Straight Up Graham and Dodd

“What did I decide to do? I moved to the Bay area. This was the perfect opportunity because losing had become the expectation in Oakland. If we tried something really innovative and it didn’t work, all we’d be doing is fulfilling expectations. To use a scout’s term, there was a lot of upside. If somehow we figured out how to put a playoff caliber team on the field for pennies on the dollar, the baseball world would have to take notice.” 

Going to Oakland was basically a cigar butt investment that had virtually no downside and all upside.  It allowed DePodesta to experiment freely; whereas, with the Indians he couldn’t due to their previous success.  He’s doing the exact same again with the Browns.  Where’s the downside?  The Brown’s are one of the worst organizations in football.  Dhando in action.

Information Overload

“Then I encountered another problem in baseball—information overkill. Between stats, scouting reports and ESPN, there’s too much information and it’s difficult to decipher what was important and what didn’t matter. Naturally, our brains go searching for cause and effect relationships, but there was too much noise. The problem was that baseball people would draw conclusions from baseball stats that just didn’t matter. It was difficult to distill what was important. We started making up relationships and people bought into them and the myth was perpetuated.” 

That is right on the bullseye for investing in today’s world.  We have a ton of information at our fingertips which we can access in seconds.  We have access to information from companies, Google, investment websites, newspapers, Twitter, Bloomberg and tons of other sources that were unavailable not that long ago.  With so much information it’s hard to remember what matters.  As DePodesta points out, figure out what’s really important and forget the rest.

Differentiation/Edge

“We didn’t have the resources to keep up with everybody else and the idea of following best practices within our industry, we knew that wasn’t a great strategy for us,” DePodesta said. “In fact, it was probably a losing strategy for us because we didn’t have the resources to keep pace. So our challenge was to try to create new best practices and ones that would actually provide us some sort of competitive advantage. The only way for us to do that was to look outside of baseball for inspiration.”

To beat the market, you must be different than the market.

“I was on a quest to find relevant relationships. Usually it wasn’t as simple as “if X then Y.” I was looking for probabilistic relationships. I christened the new model in the front office: “be the house.””

“We may not always be right but we’d be right a lot more often than we’d be wrong. In baseball, if you win about 60% of your games, you’re probably in the playoffs.”   

This guy was born to be an investor.  Peter Lynch likes to say, “In this business, if your good, you’re right 6 times out of 10.”  DePodesta’s approach of being the house is basically him saying what’s our edge?  If we can get an edge and be right more times than we’re wrong, we’ll do pretty good.  This approach definitely works in investing, but I’m curious whether it works at the highest level of sports?  Making the playoffs is good, but the ultimate goal and prize is to win it all.  In investing being first doesn’t matter.  If you are above average for a long time you are basically a god (and rich).  If you make the playoffs 4 years in a row, but lose every time you’re considered a failure (well to some fans).  Does winning on average lead to winning championships?  I guess you could argue that it increases you odds of winning a championship by simply making the playoffs.  Anyway, I’m getting off subject.

Keeping Your Emotions in Check

“Dealing with our own decision-making was relatively easy. As long as we maintained some kind of emotional detachment that comes with running a casino and knowing that in the end it’s going to work out, we would be able to maintain a high level of confidence and discipline. We would avoid making lazy decisions.”

Emotional detachment in investing is a must.  Focus on the process rather than the outcome.  This is incredibly hard to do as we’ve seen so far this year.  Stocks have been in the red and invariably this leads to emotions running high, which leads to irrational decision making.  Focus on the fundamentals of the underlying company, not the price movements of the stock.

Good Outcomes vs. Good Decisions

“I was in Las Vegas for a weekend playing blackjack. A person at the table to my right had 17 and said they wanted a hit. The whole table stopped and even the dealer asked if he was sure he wanted a hit. Finally he said he wanted a hit. The dealer deals the card and of course it was a four. What did the dealer say? “Nice hit.” But I’m thinking, you’re kidding me. It was a terrible hit. Even though it ended up working out, it wasn’t a good decision.” 

Just because a stock is up doesn’t mean it was a good decision.  And conversely, just because a stock is down doesn’t mean it was a bad decision.  This to me is one of the toughest things to explain to people.  You either get it or you don’t.  (if you’re reading this blog post you probably get it)

Random Stuff:

“It is not the first time DePodesta has stepped out of the sports world to work on something else. He has sat on the Sears board of directors for the past three years. When Sears chairman Edward Lampert announced his addition, he noted that DePodesta’s “ability to scrutinize data and use it to assess talent and drive execution makes him ideally suited to join our board.”

ESL!  Well maybe the AFC North will be safe after all.  Jokes aside, I was surprised by this.  I’m not too familiar with the Sears story, but I’d be interested to know DePodesta’s involvement and level of influence on Sears/ESL.

“DePodesta has also branched out into financial services and done advisory work for venture capital companies. After Moneyball came out, Michael Mauboussin, currently a managing director at Credit Suisse, reached out to him, and it led to time spent with Bill Miller, the former chairman of Legg Mason Capital Management. DePodesta now jokingly calls Mauboussin a “partner in crime.”

Mauboussin his PIC, makes perfect sense.

Conclusion

I would recommend reading the whole letter.  There is a ton of great detail regarding management, implementation of new systems, how to deal with changing perception and some other gems.  He’s obviously a very smart guy and one that I have a feeling might do some good outside of the sports world in the future.  He alludes to this in some of his interviews.  As for football, it’ll be interesting to see what he does with the Browns.  The value investor in me wants to see him succeed, the Ravens fan in me wants him to get fired by the owner after 1 year.  We’ll see.

DePodesta closes with this quote:

Thomas Kuhn wrote, “the proliferation of competing articulations, the willingness to try anything, the expression of explicit discontent, the recourse to philosophy and to debate over fundamentals, all these are symptoms of a transition from normal to extraordinary research.”

 

 

Links:

The Genesis, Implementation, and Management of New Systems

PAUL DEPODESTA EXPLAINS HIS PATH TO THE CLEVELAND BROWNS

Can a Moneyball Maven Fix the Browns?

Cleveland should be optimistic after Browns’ innovative DePodesta hire

The Structure of Scientific Revolutions: by Thomas Kuhn