A look at the similarities between fantasy baseball and the stock market.

As an equity research analyst by day, and fantasy baseball fanatic by umm….always, it has occurred to me that two of my biggest interests are strikingly similar. The easiest way to see the parallels is by starting with the auction draft.

Final auction prices for players are determined by supply and demand, just as stock prices represent the price the last transaction took place at, which was also agreed upon through supply and demand. However, the price a player is eventually auctioned off for doesn’t necessarily equate to his true value. As we know, many factors contribute to what price a player will go for in an auction. This is no different than with public companies. The Efficient Market Hypothesis (EMH) states that prices on traded assets reflect all known information. If this were true, then yes, stocks would trade at exactly their intrinsic value. However, since I believe in a much weaker form of the EMH, this means that stocks also don’t necessarily sell for their true value.

Imagine your league, each owner having a finite $260 to spend on players, and compare that with the global population’s cash available for investment, also a finite number. Just like the $3,120 (12-team league) in your auction will be used to purchase players, following the laws of supply and demand, so will the world’s investment cash be used to purchase stocks.

During an auction, we value players based on their expected future production. This is no different than when you buy a stock. No one buys a stock because last year its earnings doubled, just like no one buys a player because last year he hit 50 homers. You buy a stock because you believe its future earnings warrant a purchase or the player is likely to hit 55 homers. Of course, taking historical performance (whether financial or offensive) into account is an important factor for predicting future performance, but you’re still making your purchase based on that expected future.

When you value a stock, you should find out everything there is to know about the company. You would read up on its business model, analyze its historical financial statements, read the 10-Ks, etc. You wouldn’t simply look at its business model, think to yourself “gee, this sounds like a good idea” and purchase the stock. The same goes for valuing and projecting baseball players. You should not become enamored with a player’s tools and drool at that exciting power/speed combination or that 98-MPH fastball and then automatically outbid everyone else at the draft table without looking at the rest of the picture; the rest of the picture meaning historical performance- has the player actually used these tools to succeed or are you just rolling the dice hoping this is the year he magically “puts it all together”?

“Buy Low, Sell High”. This is not just a mantra in fantasy sports, but in the stock market as well. If you find a solid company selling at a price you believe to be a discount to its true value, you would be “buying low”. If the stock finally gets recognized and then investors overcompensate by bidding up shares, the stock will become overvalued (assuming no change in fundamentals), and you would then “sell high”. This is no different than fantasy baseball. You find an established player, let’s say a pitcher, who currently sports a 35% BABIP and/or a 20% HR/F rate. Clearly his ERA will be inflated because these rates are way above the mean and likely to regress, so he would become a great “buy low” candidate. On the other hand, you find another established pitcher sporting an unsustainable 20% BABIP and/or a 3% HR/F, and you have found your “sell high” candidate (assuming you own him).

What about changes in fundamentals? When a public company misses consensus estimates or reduces future guidance, shares almost always fall. This would be akin to a loss of power for a hitter or a loss of velocity for a pitcher which would cause their values to drop as well.

So although I’m not sure I really said anything groundbreaking, or even useful for your fantasy team, I thought it would be interesting to point out all the similarities between this great hobby and stock market investing. If you use the same thought process you use when investing, and treat your fantasy team like your portfolio, you might see more clearly how valuing future expectations is the key to a successful fantasy baseball season.

Questions, comments, criticisms, praise, expert league invitations? Email me at FBGeneralsMike@gmail.com.