A brief hiatus

I recently received three books to review, but I’m going to be a bit slower than usual because I have a lot of other things on my plate right now. I have not abandoned you!

Happy Memorial Day

In a singularly non-patriotic post, here's an old Animal Planet video that I received via a basset breeder friend. It may be a tribute to problem-solving, canine style. Or more likely an example of clever training. Whatever the case, it’s funny.

Playing the ponies, part 3

In this, my final post on Robert Bacon’s Secrets of Professional Turf Betting, I’m first going to share the passage that was highlighted in the Daily Speculations blog and then look at the chapter entitled “You Must Speculate—You Can’t Grind.”

The would-be professional must learn how to translate every price and every bet into a matter of percentages. He has to get a feel for prices. So each day before the races are run, he should mark down his favorite and his second choice in each race for the next day. Then he should compare his selections and prices with the prices actually paid in these races (published in the results charts after the races are run). “Whatever you do, go over the results charts in detail after the races. Study not only the prices of the money horses, but also the prices of the losers.” (p. 61)

After the student is successful at these “paper” predictions, he should try picking the first through fourth choices in each race. And eventually, he should begin making full lines on entire races—before post. “But here is something to remember. DON’T look at anybody else’s selections or prices or handicaps before making your own selection and prices. That is a rule with no exceptions. If you look at some other prices or selections first, the line you will come up with will be a sort of scrambling of his line and your line. Almost invariably, it will combine the weakest features of both. You’ll have the mistakes and the trite opinions of his line and yours. But the possible ‘bright work’ and getting-away-from-the-public part of his figures and yours, will be discarded.” (p. 62)

Bacon reiterates this point in more passionate language a few pages later. Would-be professionals “must take care not to look at any papers or listen to any predictions before making prices. And, above all, they must take care not to get into conversation with any of those gabby blabbermouths who always want to express dull opinions on horses and racing. Those ‘creeps’ are POISON! The professional soon learns to avoid them at all times.” (p. 70)

And, the final takeaway I want to share from Bacon’s book is that you must speculate rather than grind, or “you must gamble rather than attempt to chisel.” (p. 83) Bacon’s point is that you shouldn’t place bets on so-called sure-things in safety positions. The player at the racetrack can’t grind or chisel because “the racetrack has all the grind and chisel privileges! … [I]f there is a Lady Luck, she favors the bold player who has the courage of his convictions.” (p. 84) “Forget all those ideas of ‘grinding out a day’s pay’. If you want to make a day’s pay at the races, get a job watering horses, or pitching manure into trucks. But never try to grind it out of the mutuels. Perhaps the quickest way to get cured of the ‘grind’ notion is to try to grind with progression betting. That cuts short the pain! The flat-bet grinder might last a month or two, or even all summer before his capital is wiped out.” (p. 87)

Playing the ponies, part 2

In the first part of this post I said that the professional bets according to a plan and uses past performance charts to pick horses. But having a plan is not the same as using a fixed system. “[I]f the public play ever did get wise to the facts of life, the principle of ever-changing cycles of results would move the form away from the public immediately. Few players take into consideration the principle of ever-changing cycles of results, although the minor ups and downs of this principle can be seen at every long race meeting.”

Bacon looks at one of the older betting systems, calling in its simplest version for a play on the horse most recently in the money. “When this system was known only to a select few, it made money for them. … But, after a time, one of the men who had made money playing it, is said to have decided to publish it and sell it to the public for a fat price. Hardly had the public commenced scrambling for copies of his system before a hundred or more imitators and system pirates began rewriting the system and using its principles for supposedly ‘new’ systems of their own. It was only a matter of a few years before there were hundreds of cheap imitations of the system. It became common knowledge among even the most ignorant players.” And what happened? “Originally, it was claimed that the method picked horses averaging 3-to-1. But soon the weight of the public’s money knocked the prices to 5-to-2. Then to 9-to-5, as more and more people learned the method and learned to read the new past performance charts which were just getting into wide circulation at the time. Then the prices came down to an 8-to-5 average. Finally, the down-trend in odds made the average price of these horses at some major tracks a scant 3-to-2. …

“Suppose the system originally had two winners out of each seven horses played, on average. That meant two winnings of $3 and five losings of $1 each, on dollar plays—all on average, of course. That gave a flat bet winning of $1 on each seven dollars invested. But when the prices were driven down to 5-to-2, the flat bet winning was wiped out. The system just broke even. And finally, at the later odds of 3-to-2 average price, the system lost $2 on each seven bets of $1, even though the percentage of winners (two out of seven) remained the same. To be accurate, we should say ‘even IF the percentage of winners remained the same.’ Because, in actual racing, the percentage of winners does not remain constant as the public’s play beats down the prices of horses picked by any set scheme.” (pp. 29-30)

Bacon claims that the turf is the “poor man’s opportunity.” He writes: “It seems that people who have failed at everything else have more chances of succeeding at turf betting than people who have been very successful. Perhaps, because the former try to follow the rhythm of results sequences, while the latter try to force the races to run their way, as they have forced everything else in their own lines.” (p. 78)

How can a person get started playing the ponies? He starts with money for ten bets—say, $20—plus $20 in reserve. He waits until he sees what he thinks is a perfect overlay spot to place his first bet. Win or lose, he has to wait patiently for another overlay spot before placing his second bet. With each bet he is using 5% of his total capital. Let’s say that he is successful and runs his capital up to $200. At that point he should reduce the size of his bets relative to the size of his account—let’s say, from 5% to 4%.

And what happens if he loses his entire starting capital? “SO WHAT? He’s been strong. He’s done his best. He just wasn’t ready. His life didn’t go with it! He didn’t hock his car, or his house, or his job. He can tell his wife he drank up the money, lost it playing poker with the boys, gave it to a sick friend, or anything! Of course she’ll put up a heated discussion. So what? She argues anyway, even if he spends a deuce on one of his hobbies. But the whole incident is forgotten in a few days. Nobody gets hurt.” Then the player studies more and “makes paper workouts day after day from the past performance papers or from his file of results charts.” He can try again the following season “with more knowledge and with more determination to have the required patience and guts.” (pp. 81-82)

(to be continued)

Playing the ponies, part 1

I don’t play the ponies because I’ve never had any interest in horse racing. But a recent post on the Daily Speculations blog sent me in search of a copy of Secrets of Professional Turf Betting by Robert L. Bacon. The book was published in 1952; I have no idea whether it is still useful to the “turf speculator.” It is, however, definitely a worthwhile read for the “financial markets speculator,” aka trader. Since there’s a lull in hot-off-the-press books, I decided to devote a brief series of posts (maybe three) to it.

Why do professionals win? They win because “they know the ‘inside’ principle of beating the races, the same principle that must be used to beat any speculative game or business from which a legal ‘take’, house percentage, or brokerage fee is extracted. That principle is: ‘COPPER’ THE PUBLIC’S IDEAS AND PLAY AT ALL TIMES!” To “copper,” by the way, is an expression that comes from the game of faro and means to bet against.

The public must be wrong because the percentage of winning post favorites at the major tracks is somewhere between 20% and 40%. When other considerations are factored in, the author claims that “as nearly as can be estimated, the public is wrong 70% of the time at major tracks.” So the public can win only about one race out of every four. And the average payoff price of the favorites is $5.58 for a $2 bet. So at best the public pays $8 to make $5.58—not exactly the kinds of results to which the professional aspires.

The bloke who uses some “senseless mechanical method, such as following the Number Six post position in every race,” does better than the player who steps into all the switches and traps. If the take is 10% and he bets eight races and a daily double at $2 each, he should come home, on average, with $16.20 of his $18 betting capital.

The professional, of course, aims to win. He sets out to win the difference between the public’s losses and the percentage of the track take. That is, after the track takes its percentage—say, 10%, the balance of what the amateurs lose is cut up among the professionals. They have coppered the public’s ideas and play.

What distinguishes the professional from the amateur? First of all, the professional has a carefully crafted plan and sticks to it (though not slavishly as we will see in the next post). Among other things, he “bets straight to win, only, because there is the least unfavorable take-and-breakage percentage against the straight position. He never bets place or show; that keeps him out of the amateur’s position switches. … Besides sticking to the win slot, the professional always makes bets of even amounts [on any given day]… [The amateur, by contrast] keeps switching [methods], amounts and positions so that he never has a worthwhile bet on a winner at a worthwhile price.” (p. 25)

The professional plan, stripped to its bare bones, is to play all the sound overlay spots. That is, play all the spots where the odds you have calculated are better than the odds at post time; if you believe the horse is 5-to-2 you don’t bet the horse if it is 8-to-5 at post time, but you do bet if the horse is 5-to-1. The professional makes one to three sound plays per day (some days no plays) at the track where he operates.

Of course, the professional has to be able to find sound overlay spots. He does this by studying past performance charts, by paying close attention to the scale of weights, and by being able to put himself in the shoes of the odds maker. He has to understand how those who calculate the odds he is trying to beat operate, which means he has to be familiar with the table of booking percentages and understand how a book (the total of all the betting percentages in a race) is tallied.

(to be continued)

Cohan, Money and Power

Goldman Sachs is not exactly the number one brand in the world. Admittedly, it’s hard to beat Apple these days in popularity contests. But Goldman doesn’t even come close: on the contrary, it’s a firm that people love to hate. William D. Cohan’s Money and Power: How Goldman Sachs Came to Rule the World (Doubleday, 2011) provides fodder for the Goldman haters, exposing among other things a long history of conflicts of interest.

Cohan’s long book is not, however, the stuff that tabloids (or Rolling Stone—think of Matt Taibbi’s piece, later expanded into
Griftopia) are made of. It’s carefully researched, with well-crafted portraits of Goldman’s leading players, definitely worth reading.

Since Cohan's book has been extensively reviewed, for this post I decided to extract some lessons for individual traders from Goldman’s successes and failures. And Goldman, lest we forget, had a lot of failures.

One lesson is to exploit the weaknesses (or laziness) of others. For instance, a Goldman trader recalled that his boss always called Friday “Goldman Sachs Day,” the rationale being that traders at other firms were goofing off on Friday. If the Goldman traders came in on Friday intent on actually doing something while others had their guard down and were less competitive, their focused energy could make a big difference.

A second lesson is to set high goals. For instance, John Whitehead said that “when a department head accepted a higher goal, he worked harder and smarter to achieve success.” Or there’s the story of the near-disastrous acquisition of J. Aron, the commodities firm. In 1982 its profits were half of what they were the year before; by 1983, there were no profits at all. Robert Rubin was given the job of turning Aron around. He in turn handed the day-to-day management over to Mark Winkelman. Winkelman presented Rubin with a business plan that called for Aron to make $10 million, “a meaningful rebound toward profitability after years of slippage.” Rubin was not impressed. He said: “Mark, ten million dollars is not why we bought J. Aron. Tell us what we need to do to make a profit of one hundred million dollars this year.” The much higher goal meant, among other things, a major restructuring, an expansion of trading vehicles, and a significant upward shift in J. Aron’s risk profile. (Previously, they ran an essentially risk-free business.)

A third lesson is to push your bet when there is an obvious moneymaking opportunity but cut back when the opportunity disappears. Of course, easier said than done. Goldman pushed hard with its currency trades in 1992 and 1993. At one point in 1993 there were 500-plus prop traders at Goldman in London, all with basically the same position and all making wads of money. But in December 1993 the dynamic began to change. For instance, a single trader had made a massive bet (over a billion pounds) that the British pound would rise against the yen. In February 1994 disaster struck; in fifteen trading days the pound lost ten percent of its value against the yen and by the time the trade was closed this lone trader had lost somewhere between $100 million and $200 million. The losses overall in the London office had spiraled out of control. One problem was that “the culture at the time—and this was throughout the trading culture—was that you don’t tell a trader what to do.” Goldman soon enough started to put sophisticated controls in place with the creation of a proprietary system that gave the firm an enormous advantage in the assessment and monitoring of risk.

Goldman’s risk management is renowned. And, of course, its complexity goes far beyond what an individual trader would ever need. But one partner explained it, at least in part, in layman’s terms: “You need to look at everything in terms of the size. You know Bob Rubin always talked about small but deep holes. You can’t afford to lose a lot of money even if the odds are very low. You just have to protect yourself.”

Au, A Modern Approach to Graham and Dodd Investing

I have to give Thomas P. Au credit. In a world in which newsletters flaunt triple-digit returns and so-called educators tantalize prospective students with riches easily won and it seems virtually everyone cherry picks the dates that demonstrate outsized returns, Au the value investor showcases his trades in 1999. It shouldn’t come as a shock given the runaway market that year that he underperformed the S&P 500. And A Modern Approach to Graham and Dodd Investing (Wiley) was published only five years later, in 2004. So score one for integrity, zero for marketing skills.

Au’s “real-time experiment,” which occupies a single chapter, humanizes an otherwise fairly dry, earnest book. The tone may reflect the decade the author spent at Value Line, I don’t know, but even though Au writes clearly and is willing to tackle some big-picture issues, his book is easy to put down and hard to pick up again. And that’s a shame because he has some ideas that might prove useful to the twenty-first century value investor.

Here I’ll share two.

Although there is no single formula to determine when a stock is attractive, Au thinks that the investor’s best bet is the investment value formula: investment value (price) = book value + (10 * dividends). As corollaries to the concept of investment value, Au suggests that “A purchase cannot be considered a bargain unless it is undertaken at roughly one half of investment value” and “An acquirer is often willing to pay roughly twice investment value for control of a company.” (p. 123) As caveats, there must be a satisfactory leverage ratio (normally debt less than 30% of capital) and satisfactory earnings (ROE of at least 10-12%).

A case in point from history—and, on a personal note, an investment that paid my salary for a year and a summer many years later. “In the late nineteenth century, Andrew Carnegie turned a ‘small’ fortune for his day, of about $1.5 million, into a very large fortune of his time. He bought an interest in a steel company at a bargain price, watched it double to investment value, compounded it at roughly 15 percent per year for a period of roughly 30 years, and sold his holdings to J.P. Morgan at about twice the going market price, the premium that Morgan was willing to pay for control in order to fold Carnegie’s steel company into what became U.S. Steel.” (p. 124) You can do the math, but basically Carnegie realized a more than 256-fold return ($1.5 million invested, $412 million return). Not too shabby. Alas, the investor who bought U.S. Steel in 1900 and miraculously lived another hundred years would have had no return on his investment.

For those who want to stay fully invested in stocks but change strategies depending on market conditions, Au describes nine market scenarios—high and rising, high and stable, high and falling, moderately priced and rising, moderately priced and stable, moderately priced and falling, low and rising, low and stable, and low and falling. “Of these nine scenarios, Graham and Dodd-type investing has a clear advantage in the three stable scenarios by emphasizing dividend income, and the three falling scenarios by focusing on capital preservation. It is also robust in two of the three rising scenarios, when stocks are low and moderately priced. Its clear disadvantage is in the high and rising scenario, which was the case in the late 1990s.” (p. 215)

Still better off is the investor who can time the market, knowing when to add to his stock portfolio and when to go to cash or bonds. Au offers some timing suggestions, including the notion of generational cycles. “A stock market cycle of 30-odd years … encompasses one strong and one weak generation.” “Strong generations, such as the Baby Boomers, run the American economy in overdrive. Weak generations, like the preceding Silent generation and succeeding Generation X, rein in the excesses of the strong generations.” (p. 307) As is often the case with long cycles, the timing of the next peak and trough is tricky. A complete 80-year generational cycle “would predict a crisis and possibly a war around the year 2021. This is close to the right time frame, but at the rate events are progressing, the climax could come just a bit earlier, in the mid- to late teens.” (p. 308) There will undoubtedly be more crises to come, but I would consider the recent financial crisis one that came far too early by generational cycle standards.