It has been quite a weekend back in Baltimore. I spent the bulk of it at the family bar over the weekend with various family members and friends. I also had the luxury of visiting the remodeled horse track in Timonium, Maryland. By “remodeled,” I mean that nothing has changed to the racing stands and structure since the 1950s. They just put a bar in the middle of it. And sure enough, it is absolutely packed – even in the middle of COVID-19. The big event around these local horse races was the Maryland State Fair.
I can’t really describe the Maryland State Fair – so I won’t. The attendees should probably save their money for a rainier day than pay $5 for a dart to pop and win a stuffed animal that clearly costs $0.25. But that’s the hustle. As I walked from the family bar to the horse grandstand, I could see the crafty salespeople at the games trying to get me to come pay an overpriced game while he was accepting money from the latest sucker. I have to credit their entrepreneurialism. And to be honest, I don’t really have space for any more trinkets.
It had been sometime since I’d been to the track. The local horse racing in Timonium isn’t exactly rivaling Churchill Downs. Most of the horses that are favorites are stepping down from a graded race. Their owners are doing all they can to get their horses a win before sending them out to auction. The other horses – the long shots… they might as well be smoking cigarettes in between races. If they could talk, they’d speak like a 45-year-veteran behind a riverboat bar. “It’s a job,” they’d cough.
Horse Race Betting vs Stock Market Trading
There was a really great reminder about one of my favorite financial books of all time. And it just happens to be about horse racing. The book is called Value Handicapping. It was written by Marc Cramer, and it’s sold for about $125 on eBay.
The book lays out how the best gamblers in horse racing avoid betting on favorites. After all, the favorites win about 37% of the time. If the local horses are going off at 4-to-5 or even a flat 2-to-1 the numbers dictate that you should avoid betting on them.
You need a bet that justifies the historical track record of these horses. What happens is that value handicappers look for the horses that are going off at more attractive odds than what their speed and history would dictate. You’ll notice a few horses going at much longer odds than they started, only to see their odds drop in the last two minutes before the race. Those are the value handicappers betting. If they rate a horse’s real odds at 7-to-1, but the horse is going at 14-to-1, they make their bet.
And it makes sense. The purpose of this exercise isn’t to watch pretty horses. It’s about making money. And this strategy of finding payoffs that are much higher due to a mispricing is clearly a more intelligent strategy.
The mathematics behind this practice are used constantly by great stock market trading value investors. They’re used by Black Swan portfolio investors who look at something priced at a 10-to-1 payout, but could end up making an investor 30 or even 40 times their money. The math is also used in venture capital and private equity when they measure the value of the assets and assess risk and potential returns.
There are plenty of hedge fund managers who started in horse racing and poker. An understanding of the probabilities is essential. From there, it’s all math. I’ll be back to talk more about real value in the market later this week.