From Poker to Investing: Always Look Ahead</HEADLINE>
By <AUTHOR>Jeff Hwang</AUTHOR>
<DATE>April 20, 2005</DATE>
<!--startindex--><BODYTEXT>In Part 1, we took three of poker theoretician Mike Caro's tips from Doyle Brunson's Super/System 2 and applied them to investing. In Part 2, we will take a look at three more tips from the Mike Caro University (MCU) and discuss the importance of valuation, being a forward-looking investor, and the idea that investors do not get bonuses for making tough choices.
MCU Tip No. 1: In the beginning, everything was even money.
The lesson: An investor's advantage comes from the ability to gauge valuation and expectations.
As Matt Damon said in the movie Rounders, "Get your chips in when you have the best of it; protect them when you don't." That's the key. The question: How do you know when you have the best of it?
The answer: By understanding valuation.
In poker, every player gets dealt the same cards over the long run. The fundamental difference between long-run winners and losers is an understanding of value -- the value of the cards you're dealt, the value of your position relative to the other players at the table, and how the value of your cards changes given the actions of the other players at the table.
Similarly, investors for the most part are all choosing from the same field of stocks. And the one thing that separates the investor with a winning long-term strategy apart from everybody else is the ability to appropriately value stocks. After all, if you have no idea when a stock is cheap or expensive, how are you going to know when to buy, sell, or hold?
That said, it is not enough to go out and buy Home Depot (NYSE: HD) or Best Buy (NYSE: BBY) simply because you like the stores and both companies are top players. Get an idea of what the stocks are worth -- compare P/E ratios, cash flows, dividend payouts, or whatever else you think is relevant.
Or if you're interested in a growth business that is difficult to value -- such as satellite radio plays XM Satellite Radio (Nasdaq: XMSR) and Sirius Satellite Radio (Nasdaq: SIRI), or Motley Fool Rule Breakers selection Overstock.com (Nasdaq: OSTK) -- at least have a gauge on where you expect the company to be four or five years down the line. If your expected return from the current stock price doesn't justify the risk, then at least you know not to buy.
MCU Tip No. 11: Poker's stupidest question: "Why didn't you quit when you were $17,000 ahead?"
The lesson: Always look ahead. If the business quality and valuation favor a hold, then the correct decision is to hold on to the stock.
Top poker pro Phil Ivey -- often referred to as the "Tiger Woods of Poker" -- once said in a TV interview that so long as you're playing well and the game is good, it is to your advantage to keep playing until the game breaks up or you get tired.
This makes perfect sense. If a stock you buy doubles or triples but the long-term prospects for the business and the stock's valuation are still favorable, then why sell? And when the stock falls 20% in the short term for no good reason, don't panic and kick yourself for not selling -- this is the time when long-term investorssalivate and get greedy.
Example: Ameristar Casinos, March 2003 to February 2005
Here's an example. A little more than two years ago in March 2003, I did a write-up on Ameristar Casinos (Nasdaq: ASCA) -- a top-notch riverboat casino operator with rapidly growing market share and arguably the top property in every market in which it competes -- and recommended the stock at just under $11 per share.
At the time, the company carried an enterprise value at about 5 times to 5.2 times the company's estimate of $190 million to $200 million in 2003 EBITDA, a valuation that is on par with the weakest players in the industry. As a premium player, I felt the company was worth at least 6 times EBITDA, if not closer to what premium players such as rival Harrah's Entertainment (NYSE: HET) should have reasonably fetched at the time at 7 times or 8 times EBITDA. I felt particularly strong about this, as at the time Ameristar held its market position while competing against Harrah's in each of its four riverboat markets in Missouri, Mississippi, and Iowa.
So there was plenty of headroom here. At 6 times the low-end estimate at $190 million in 2003 EBITDA, the stock would be worth $16.50. At 7 times, the stock would be worth $23.75, and at 8 times EBITDA, the stock would be worth $31 per share.
By April 8, 2004, the stock had hit $37.75 for a clean triple-plus, yet the company was still trading at just more than 6 times 2004 EBITDA, a clear hold at the very low end of my estimate for fair value. But by July 27, the stock had fallen back to $30.45, before dropping 16% to $25.65 the next day following the company's second-quarter earnings report.
But here's the thing: The business was still strong, the prospects were bright, and now the company was trading at a measly 5.5 times to 5.8 times 2004 EBITDA. At this point, the stock was a clear buy.
Ameristar continued to perform as a business, and casino stocks in general had gained favor on Wall Street. And on Feb. 4, the stock closed at $49.55 following the company's fourth-quarter earnings report, almost a double from its panic price just six months earlier. The stock is now trading at around $55 as of today.
The point here is that it would have been way too easy for an investor to panic sell once the stock fell from $37.75 to $25.65 in a span of less than four months. It also would have been way too easy to curse yourself for not selling at $37.75 while you were 250% ahead. But the enterprising investor armed with MCU Tip No. 1 -- valuation gauges -- can see the value in holding at $37.75 when the stock is reasonably valued or better, and can get greedy and push his chips in when the company is dirt cheap at $25.65 and 5.5 times to 5.8 times EBITDA.
The ability to do so will reward an investor handsomely over the long run.
MCU Tip No. 14: Beating strong foes wins much respect and little money; beating weak foes wins little respect and much money.
The lesson: Investing is about what makes the money in the long run.
Remember: Investors get paid for making correct decisions. There is no bonus for attacking complex companies, or making tough choices. Often times, you'll find that the best investment decisions you make will be both simple and obvious.
By <AUTHOR>Jeff Hwang</AUTHOR>
<DATE>April 20, 2005</DATE>
<!--startindex--><BODYTEXT>In Part 1, we took three of poker theoretician Mike Caro's tips from Doyle Brunson's Super/System 2 and applied them to investing. In Part 2, we will take a look at three more tips from the Mike Caro University (MCU) and discuss the importance of valuation, being a forward-looking investor, and the idea that investors do not get bonuses for making tough choices.
MCU Tip No. 1: In the beginning, everything was even money.
The lesson: An investor's advantage comes from the ability to gauge valuation and expectations.
As Matt Damon said in the movie Rounders, "Get your chips in when you have the best of it; protect them when you don't." That's the key. The question: How do you know when you have the best of it?
The answer: By understanding valuation.
In poker, every player gets dealt the same cards over the long run. The fundamental difference between long-run winners and losers is an understanding of value -- the value of the cards you're dealt, the value of your position relative to the other players at the table, and how the value of your cards changes given the actions of the other players at the table.
Similarly, investors for the most part are all choosing from the same field of stocks. And the one thing that separates the investor with a winning long-term strategy apart from everybody else is the ability to appropriately value stocks. After all, if you have no idea when a stock is cheap or expensive, how are you going to know when to buy, sell, or hold?
That said, it is not enough to go out and buy Home Depot (NYSE: HD) or Best Buy (NYSE: BBY) simply because you like the stores and both companies are top players. Get an idea of what the stocks are worth -- compare P/E ratios, cash flows, dividend payouts, or whatever else you think is relevant.
Or if you're interested in a growth business that is difficult to value -- such as satellite radio plays XM Satellite Radio (Nasdaq: XMSR) and Sirius Satellite Radio (Nasdaq: SIRI), or Motley Fool Rule Breakers selection Overstock.com (Nasdaq: OSTK) -- at least have a gauge on where you expect the company to be four or five years down the line. If your expected return from the current stock price doesn't justify the risk, then at least you know not to buy.
MCU Tip No. 11: Poker's stupidest question: "Why didn't you quit when you were $17,000 ahead?"
The lesson: Always look ahead. If the business quality and valuation favor a hold, then the correct decision is to hold on to the stock.
Top poker pro Phil Ivey -- often referred to as the "Tiger Woods of Poker" -- once said in a TV interview that so long as you're playing well and the game is good, it is to your advantage to keep playing until the game breaks up or you get tired.
This makes perfect sense. If a stock you buy doubles or triples but the long-term prospects for the business and the stock's valuation are still favorable, then why sell? And when the stock falls 20% in the short term for no good reason, don't panic and kick yourself for not selling -- this is the time when long-term investorssalivate and get greedy.
Example: Ameristar Casinos, March 2003 to February 2005
Here's an example. A little more than two years ago in March 2003, I did a write-up on Ameristar Casinos (Nasdaq: ASCA) -- a top-notch riverboat casino operator with rapidly growing market share and arguably the top property in every market in which it competes -- and recommended the stock at just under $11 per share.
At the time, the company carried an enterprise value at about 5 times to 5.2 times the company's estimate of $190 million to $200 million in 2003 EBITDA, a valuation that is on par with the weakest players in the industry. As a premium player, I felt the company was worth at least 6 times EBITDA, if not closer to what premium players such as rival Harrah's Entertainment (NYSE: HET) should have reasonably fetched at the time at 7 times or 8 times EBITDA. I felt particularly strong about this, as at the time Ameristar held its market position while competing against Harrah's in each of its four riverboat markets in Missouri, Mississippi, and Iowa.
So there was plenty of headroom here. At 6 times the low-end estimate at $190 million in 2003 EBITDA, the stock would be worth $16.50. At 7 times, the stock would be worth $23.75, and at 8 times EBITDA, the stock would be worth $31 per share.
By April 8, 2004, the stock had hit $37.75 for a clean triple-plus, yet the company was still trading at just more than 6 times 2004 EBITDA, a clear hold at the very low end of my estimate for fair value. But by July 27, the stock had fallen back to $30.45, before dropping 16% to $25.65 the next day following the company's second-quarter earnings report.
But here's the thing: The business was still strong, the prospects were bright, and now the company was trading at a measly 5.5 times to 5.8 times 2004 EBITDA. At this point, the stock was a clear buy.
Ameristar continued to perform as a business, and casino stocks in general had gained favor on Wall Street. And on Feb. 4, the stock closed at $49.55 following the company's fourth-quarter earnings report, almost a double from its panic price just six months earlier. The stock is now trading at around $55 as of today.
The point here is that it would have been way too easy for an investor to panic sell once the stock fell from $37.75 to $25.65 in a span of less than four months. It also would have been way too easy to curse yourself for not selling at $37.75 while you were 250% ahead. But the enterprising investor armed with MCU Tip No. 1 -- valuation gauges -- can see the value in holding at $37.75 when the stock is reasonably valued or better, and can get greedy and push his chips in when the company is dirt cheap at $25.65 and 5.5 times to 5.8 times EBITDA.
The ability to do so will reward an investor handsomely over the long run.
MCU Tip No. 14: Beating strong foes wins much respect and little money; beating weak foes wins little respect and much money.
The lesson: Investing is about what makes the money in the long run.
Remember: Investors get paid for making correct decisions. There is no bonus for attacking complex companies, or making tough choices. Often times, you'll find that the best investment decisions you make will be both simple and obvious.
