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What Betting on Boxing Can Teach Us about Investing: Value Stocks and Higher Expected Returns Thumbnail

What Betting on Boxing Can Teach Us about Investing: Value Stocks and Higher Expected Returns

I’ll state right here at the outset that I don’t follow boxing. I know a couple of names, but the closest I came to being a boxing fan was playing Mike Tyson’s Punch-Out on my old Nintendo system what seems like 100 years ago. But I saw an article on ESPN.com related to boxing that I thought could serve as a great example of value investing.

On Saturday, September 13, Floyd Mayweather beat Marcos Maidana in a unanimous decision to retain his welterweight and junior middleweight world titles. In many boxing circles, Mayweather is considered to be the best pound-for-pound boxer in the world. So it shouldn’t come as a surprise that many people thought Mayweather would win.

It’s legal to bet on boxing in Las Vegas, but it’s a little more complicated than just placing money on who you think is going to win. In order to try to balance the betting on both sides, sports books will place odds on each boxer. That way, you can still bet on the favorite if you want to but your payout will be lower, since the favorite is already expected to win. Larger potential payouts come if you bet on the underdog.

On Saturday, Mayweather wasn’t just the favorite to win. He was a HUGE favorite. When the fight started, Mayweather was a minus-600 favorite, which in the language of boxing odds means that in order to win $50 you had to be willing to wager (and potentially lose) $300. That’s how much it cost to get a sure thing.

As it happened, many more bettors tried for the big payout and wagered on Maidana. That same $300 bet would have brought back $1,500 if he had somehow won.[1]  As it turned out, when he lost, the casinos turned out to be the big winners, as they kept all the money bet on Maidana.[2]

Translate this into the stock market: if most people believe that a particular stock is a good investment, chances are those beliefs are reflected in the current price. That means that future returns for this stock should be relatively lower, as the price of the stock has already been driven up to reflect those beliefs.

Contrast that with a stock that isn’t so popular. Maybe it’s suffered some bad press, had a significant product recalled, or recently been fined. Whatever the reason, people have sold off this stock and pushed the price down. Which stock is more likely to have a higher return going forward: the super-popular one that is already priced accordingly or the ugly duckling that is beaten down? Put another way, which stock has the better value with the higher expected return?

If you guessed the ugly duckling, you’re right. In fact, from 1927, these ugly duckling value stocks have outperformed the much more popular growth stocks by about 4.99%/year on average.[3]

This doesn’t mean that investors should put all of their money into the least-loved stocks. The outperformance doesn’t happen every year, it’s not always by a huge amount, and in some cases underperfomance can persist for a few years in a row. There’s a reason why these stocks have a low relative price; risk and return are always related.

But the long-term numbers don’t lie. Accordingly, at Woodward Financial Advisors, we build our clients’ portfolios by starting with the broad stock market, and then tilting the portfolio a little more towards value stocks. We think portfolios built on this dimension of higher expected returns gives our clients a puncher’s chance of better outcomes, relative to simply investing in the overall market.

[1] Maidana was a +500 underdog, so a bettor wagering $100 would have won $500 if Maidana had beaten Mayweather

[2] For those blog readers who receive our quarterly financial commentary, stay tuned for a discussion about how the stock market is NOT like a casino, despite what you might have heard.

[3] Source: Dimensional Fund Advisors

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