A PARALLEL UNIVERSE AT THE KEENELAND AUCTION

Dollars were flowing at the 2011 Keeneland September Yearling Sale like champagne on New Year’s Eve in the heyday of Guy Lombardo at the Waldorf Astoria. This spending extravaganza came despite a litany of bad news from elsewhere.

The world is being roiled by fears about a credit default by Greece and the worsening debt situation in Ireland, Italy, Portugal, and other countries that use the Euro as a currency. Adding fuel to the fire, the China economy is slowing and there are growing concerns about a double-dip recession in the United States and Europe. As a result of all the tumult, securities markets around the globe have been erratic. Last week saw the worst losses in the Dow-Jones Industrial Average in three years—off 6.41 percent for the week—and Hong Kong’s Hang Seng also suffered the biggest loss since 2008—9.2 percent.

Meanwhile, down in the bluegrass of Kentucky, there was a seemingly parallel universe with a distinctly separate reality. Day-after-day, the Keeneland sale was turning in a stellar performance, while day-after-day the world’s stock markets were mostly destroying wealth.

In Lexington, it was as though the macroeconomic environment and the negative spiral in North American pari-mutuel handle do not matter to bloodstock prices. The report that U. S. pari-mutuel handle plunged by 12 percent in August evidently did not have any effect. The Keeneland sale concluded with double-digit increases over 2010: gross revenues, +12 percent; average price +18 percent, and median price +20 percent.

Why did the 2011 Keeneland sale do so well in the midst of the most uncertain economic environment since Lehman Brother filed for bankruptcy in mid-September 2008? Was the Keeneland auction an “ostrich event” in which buyers figuratively put their heads in the sand, merrily spending as though business conditions are hunky-dory?

One can only hypothesize about the reasons why the Keeneland sale was so contrarian.

The explanation that sale prices were run up by optimistic foreign buyers doesn’t have the ring of truth because economic conditions are dicey everywhere.

The view here is that the elevated prices for the premier yearlings are largely attributable to the characteristic of horse racing that it is more sport than business at the upper-most price points. Deep-pocketed buyers are so wealthy that they are not much affected by stock-market declines and tepid business conditions. What’s more, the desire to see a yearling develop into a prestigious Grade I or Group I winner often trumps economic considerations.

However, the healthy performance metrics at the middle and lower ends of the sale—for the less fashionable yearlings–defy such an easy answer. Buyers at these more moderate price points typically tend to be circumspect because they are constrained by budgets. Such “value investors” must weigh the economic rationale for a yearling purchase.

Candidly, I can’t explain with a modicum of confidence why the middle and bottom segments of the sale were bullish—given that pari-mutuel handle is so depressed. My best guess is that strong demand from racing partnerships and pinhookers was the main reason. These buyers by necessity left the big spenders to vie for the ostensibly most desirable yearlings and then drove up prices for the best of what was left.

Another possibility is that some buyers were anticipating racino-enriched purses at Aqueduct.

Lastly, a rapid increase in asset prices that does not appear to be justified by underlying economic fundamentals always raises the possibility of a bubble. For example, the latest reincarnation of the famous Dutch Tulipmania craze–circa 1630s, the archetype of all bubbles–was the run-up in U. S. housing prices followed by a glut of unsold homes that are worth less than their mortgage loan amounts.

What transpired in Keeneland’s sales ring is a welcome relief for a hard-hit horse racing enterprise, but the continuing decline in pari-mutuel wagering looms large.  At some unknowable point, bloodstock prices should correspond more closely to trends in pari-mutuel  handle.

Copyright © 2011 Horse Racing Business

WHAT I LEARNED ABOUT INVESTING IN STOCKS FROM BETTING ON HORSES

As a longtime recreational bettor on horse races and a serious investor in stocks, I have found that guiding principles apply to both activities.

Avoid Touts and Tips. Horse racing and stock investing are ventures in which someone “in the know” is eager to provide you with a tip on the next sure thing. Usually avoid these people like the plague because, if they really knew, they would not be telling you at the racetrack or informing millions of viewers on a cable TV business channel. Without fail, every year right before the Kentucky Derby, a so-called wise-guys’ horse emerges only to badly falter when it comes time to show what he has.

Watch Out for Insider Trading. Regard all purportedly “inside information” with much skepticism. To be sure, there are times when a backside worker you know has a valuable scoop about a maiden colt or filly that is going to contend in a race based on sensational recent workouts. Trouble is, while a bet on the maiden could be worthwhile, the informant has probably told enough people  that the horse’s odds at post time will be too low, given the level of risk.

In the same vein, say an acquaintance of yours who is a company executive confides that his firm’s stock will receive a boost from a yet-undisclosed impending acquisition by a competitor. Remember, if you buy the stock before the information goes public, that pesky Securities and Exchange Commission may find out and nominate you for a compulsory stay at a federal minimum security facility. Tips on horse races don’t have this downside.

Always ask yourself why you are the privileged recipient of the inside information and why the tipster thinks so much of you to let you in on the secret.

Research, Research, Research. Investing in stocks profitably and betting on horses just to break even require a thorough analysis of the underlying fundamentals. Regardless of what other people tell you, even experts, do your own delving into the details.

Be Selective. After you thoroughly research stocks and horses, there will be a lot more companies and entries that you don’t want to bet on than there are that you do want to bet on.  Being patient and disciplined and sitting on your hands with a cash position while waiting on promising opportunities is a mark of a shrewd investor or bettor.

Never Forget the Meaning of Value. Advertisements on CNBC, Bloomberg, and other websites sometimes bill “stocks to own for life.” Yet the late investment authority Benjamin Graham correctly taught students like Warren Buffett that every stock has an intrinsic value determined by the discounted value of its future earnings stream. No matter how strong a company happens to be, its stock can be overvalued at a point in time and therefore not worth buying. Race entries, like stocks, can be fairly valued, undervalued, or overvalued. Whether it is picking stocks or picking racehorses, look for the overlays and avoid the underlays. Otherwise, your cash pile will contract over time. Neither Havre de Grace to win at 1-9 odds nor Apple at $2,000 per share is a prudent buy.

Diversify. This precept–perhaps the most important of all–is about spreading risk and managing money. “Putting all your eggs in one basket” is to be avoided if you want to have any eggs left to invest or wager another day. Pick-six syndicates allow a bettor to own a fraction of a big ticket with lots of combinations, just as ETFs allow one to buy, say, the S&P 500.

Hedge. Since no one can consistently predict short-term market movements, cautious investors use various options strategies like puts and calls and simultaneous short/long positions to temper market risks. Likewise, savvy bettors rely on exacta boxes and other methods of hedging just in case the favorite gets nipped at the wire.

Control Emotions. This is difficult to do when the Dow plunges 500 points in a single day and you are down four or five percent of your portfolio. When you haven’t cashed a ticket in days, it can also be agonizing and destructive of self-confidence. However, successful investors and horse players are inevitably going to have winning streaks and losing streaks and should take them in stride. A trait of true professionals is that it is not easy to discern from observing them whether they have been winners or losers. If you can’t handle the emotional ups and downs of the stock market, turn your portfolio over to an expert you trust. If you can’t handle the emotional ups and downs of betting horses, wager only enough to introduce some fun and chance into your day at the races, but don’t bet enough to care much even if you lose it all.

After this week’s global stock-market sell-off, if you are still invested in stocks and remain reasonably calm and sane, you have passed this emotional-stability test with flying colors, although your judgment may be in question.

Minimize Takeout. Stock broker commissions can eat away at profits if you trade frequently, although the advent of online trading has greatly diminished trading costs. On the other hand, the relatively high takeout percentages on horse-race bets (as opposed to other gambling games of skill) have generally not diminished in the Internet era—which is why wagering on horse races can be an entertaining diversion but is an unattractive way for making money. Unless you bet enough to demand sizeable rebates, you are almost certain to lose over a sustained period of time.

Postscript: I was visiting Saratoga Springs, New York, in early-to-mid August 2011 at which time world stock markets were trading erratically, but mostly on the downside–the U. S. markets lost nearly 20 percent ot their value in a four-week period in July and August.  While I was in Saratoga, the races were going on in the afternoon and the Fasig-Tipton sale of yearlings was being held at night.  I wondered to myself what kind of person can risk money betting on horses in the afternoon (a few of which he or she may own), check the stock market at 4 PM to see how his or her portfolio has fared in a brutal market, and then be in a sufficiently healthy emotional state to attend the sale at night as a buyer or seller of untried and expensive futures in the form of yearlings that may never make it to the races. These folks truly live life on the financial edge.

Copyright © 2011 Horse Racing Business

BETTING ON BYTES

Racetrack executives are sometimes criticized for putting so much emphasis on advance deposit wagering. The evidence mounts in industry after industry that racetracks have no choice if they want to remain in business and expand revenues and profits.

The Economist magazine (July 9, 2011) posed the question: “Who killed the newspaper?” It went on to say that the person most often blamed in the United States is “Craig Newmark, the founder of Craigslist, a network of classified-advertising websites…” It is truly amazing that one person can have such a negative effect on such a huge industry that has been around for so long. He had plenty of help, of course, from other Internet sites and cable television.

Fortune magazine recently examined (“Bytes Beat Bricks,” July 4, 2011) the performance of four formidable bricks-and-mortar companies since 1999 compared to four digital rivals. Like The Economist article about newspapers, the results demonstrate just how disruptive the Internet has been to any business whose core product can be delivered digitally.

In the years 1999 through 2010, the United States Postal Service saw its mail volume decline by 19%, as email and text messaging have soared in popularity. Cellphone messages in 2010 were about 1.9 trillion, for an increase of 1,200,243% over 2000. The USPS estimates that it will lose $6 billion in 2011. Remember when working at the USPS was thought of as having a high degree of job security?

From Netflix’s founding in 1997 until the end of 2010, sales went from zero to $2.2 billion. Meanwhile, the former kingpin of movie rentals, Blockbuster, filed for bankruptcy in September 2010 after its 1999 sales plummeted by 29%.

Borders books, the number two bookseller in the United States behind Barnes & Noble, is liquidating. Borders’ sales are 44% less than they were in 1999, whereas Amazon’s sales are up by 808% from 1999 to $14.9 billion.

Songs sold on CDs are off by 60% from their 1999 level as chains like Tower Records and Musicland have folded in the face of the digital onslaught by iTunes. The latter’s annual sales are up by 1,169,900% from 2003 and stand at approximately $11.7 billion.

Horse racing broadly provides entertainment and some people enjoy attending live races and have the time to do so. Nonetheless, the only business segment in racing that has been growing is gambling via advance deposit wagering. As with retailers whose products can be conveyed over the Internet, racetracks are part of the same digital trend that has undercut newspapers, the USPS, Blockbuster, Borders, and CD sellers.

Racetracks can attract people to big events like the Triple Crown and the Breeders’ Cup, but for routine day-in and day-out racing, advance deposit wagering is the best–and perhaps only–modus operandi for revitalizing the sport of horse racing.

Copyright © 2011 Horse Racing Business

Originally published in the Blood-Horse. Used with permission.