"The Science of Hitting" was a book that attracted Warren Buffett’s attention. The book was written by Ted Williams, one of the greatest baseball hitters of all times. His impact on the game, both as a player and as an inspiration to generations of hitters who followed, continues to this day. Williams combined the following:
- Power (521 lifetime home runs)
- Patience (he received more walks than any batter in his day); and
- Control (a .344 lifetime average) that no player had ever done before.
He had the intelligence of a lead-off hitter and the brawn of a power hitter; the patience of a bench warmer, and the bat control of a single hitter.
His contribution to the game was to reduce the waiting time to hit a perfect pitch; he said that a good hitter can hit a pitch that is over the plate three times better than a great hitter with a questionable ball in a tough spot. Williams knew, for example, that a high and inside strike pitted his weakness against the pitcher’s strength. If he consistently swung at those pitches, his batting average would suffer. A low and outside pitch produced the same results - a success rate far below Williams’ lifetime batting average. However if Williams received a pitch in his optimum strength zone, he put all his muscle into it, knowing that he could consistently produce a higher batting average. In constructing a template for success, Williams outlined a pattern of patience. He realized that it was often better to take a pitch on the fringe of the strike zone rather than swing for a low average. A called strike was better than making an out.
Buffett extends the same reasoning to stock picking. The stock market is like a major league pitcher who fires thousands of pitches a day, with each pitch representing a certain stock at a certain price. As the batter, you must decide which of the thousands of pitches to swing at, and which you will let whiz by. What distinguishes you from a baseball player, however, is that you don’t ever have to swing. The game of investing doesn’t force you to take the bat off your shoulder and swing, unlike the batter in the stadium. No one will “call you out”. Buffett says:
“In investments, there’s no such thing as a called strike. You can stand there at the plate and the pitcher can throw the ball right down the middle, and if it’s General Motors (NYSE:GM) at $47 and you don’t know enough to decide General Motors at $47, you let it go right on by and no one’s going to call a strike. The only way you can have a strike is to swing and miss.”
Williams would wait for a specific pitch (in an area of the plate where he knew he had a high probability of making contact with the ball) before swinging. It is said that this discipline enabled Williams to have a higher lifetime batting average than the average player.
Here are other interesting excepts from the book that may helped Warren Buffett to become a better investor.
Look at What You Are Hitting
Ted Williams said: “It dumbfounded me when a batter couldn't tell what he had hit. Bobby Doerr was like that. Doerr was a solid .280 hitter, but he’d come to the bench and I’d say, “What was the pitch?” “I dunno. Curve, I think,” even when he’d hit a home run.
It is the same in the stock market -- there are different pitches that “Mr. Market” gives you, The best classification I have read of these pitches is the one by Peter Lynch in his book "One Up on Wall Street." According to the book, there are six categories of stocks:
- Slow Growers [Consolidated Edison (NYSE:ED)]
- The Stalwarts [Coca Cola (NYSE:KO)]
- The Fast Growers [Imax (NYSE:IMAX)]
- The Cyclicals [Toyota (NYSE:TM)]
- Turnarounds [Sprint (NYSE:S)]
- The Asset Plays (Any company with something valuable overlooked by Wall Street).
If you make a large profit on any of these assets, but you don’t know which kind it is and why you did well, there is no difference between you and Bobby Doerr. You can get the ball out of the stadium once in a while, but you will never understand what you are hitting. Peter Lynch is probably the best investor of our era who understood all the different pitches of the stock market.
The First Rule for a Good Hitting is a Good Ball to Hit
According Ted Williams, the first rule for a good hitting is to get a good ball to hit -- it is just that simple. At the end of the 90’s, not only were there no good stocks to hit, but the market was overvalued, and the PE’s were irrationally high. As a consequence, the market just collapsed in the year 2000, and nobody made a home run out of it. A good ball to hit is a company with a strong balance sheet, reasonable PE ratio, great return on equity and good cash flow. Anything other than that is just a hard ball on a difficult spot -- it rarely become a home run.
Ted Williams was nothing special. He had 20-10 vision; a lot of guys can see that well. He couldn't “see” the bat hit the ball as some people wrote, but he definitely was able to appreciate when a good ball was coming. As I mentioned earlier, he used to say “a good hitter can hit a pitch that is over the plate three times better than a great hitter with a questionable ball in a tough spot. More often than not, you hit a bad pitch in a tough spot and nothing happens”.
Like Ted Williams, I believe that a good investor can make three times more profit on a good stock, than a great investor investing in a questionable asset in a tough spot.
Speculate, but Read the Environment
Sam Rice was a great outfielder for the Senators in the 1920’s and 30’s, with a lifetime average of .322. He made it to the Hall of Fame in 1963. When Ted Williams went to Washington in 1969, Sam Rice asked him: “Ted, I always wanted to ask you. Did you guess at the plate?” and Ted said: “Did I guess?, Boy, I guess I did!” Sam Rice was delighted. “I knew it” he said. “I knew it. I go around asking these young hitters today if they guess at the plate, and they say ‘No’ because somewhere along the line someone told them ‘Don’t guess.’ And the funny thing is they’re all hitting .230.”
In his book The Science of Hitting, Ted Williams said: “... well you’ve got to guess, you’ve got an idea. All they ever write about the good hitters is what great reflexes they have, what great style, what strength, what quickness, but never how smart the guy is at the plate, and that’s 50 per cent of it. From the ideas come the ‘proper thinking,’ and the ‘anticipation,’ the ‘guessing’.”
In the stock market it is exactly the same. You can anticipate the direction of the stocks by using common sense and reading clear signs from the economy or logical changes in the industry. Just an example -- whenever there is a recession, cyclical stocks do pretty bad. That includes industrials such as General Electric (NYSE:GE), and automotive brands such as Ford (NYSE:F) or General Motors. In a sorry market, solid stocks such as Coca Cola Company can lose half of their value, but a cyclical stock can lose 80 percent. If you use common sense and anticipate market movements, you may want to avoid cyclical stocks as long as the economy is depressed. Buffett once said that “Cyclicals look cheap when they are very expensive, and look very expensive when they are cheap”, anticipating the market is smart to avoid undesirable traps.
Similar to the progression of the state of dictatorship to anarchy, from anarchy to democracy, and from democracy to empire, stocks can have also different states. A once serious growing stock can become a cyclical, then get into trouble and come back as a turnaround. If you can identify which state the stock is in, you can anticipate the market with more confidence. It will never be exact, but it will definitely give you a better battling average.
When Ted Williams was missing all his swings against Virgil Trucks of the Tigers, he said to himself “I had to anticipate-to start my swing where I thought Trucks was prone to throw it-about crotch high, and up, and if I got started somewhere in between I could just adjust in time to get in front of the ball. Otherwise, if I was as fast as Trucks was I wouldn’t have been able to pull the bat”.
Know Your Stocks -- Pay Attention to the Details
Some people just buy and sell stocks without doing their homework. They don’t pay attention to the details. They don’t read annual or quarterly reports, and they don’t even check if insiders are buying or selling. They don’t even check clear signs of moving prices of the stock, such as moving averages or noticeable changes in earnings. Ted Williams was the best batter of his time because he was putting attention to the detail at all levels.
Once John Hillerich of Hillerich and Bradsby, the Lousville Slugger Company, put six bats on a bed one time. One was a half ounce heavier than the others. He had Ted Williams close his eyes and pick the heaviest bat. Williams picked it out twice in a row! Ted Williams used to clean his bats with alcohol every night because bats pick up condensation and dirt lying around the ground. They can gain an ounce or more in a surprisingly short time. For Ted Williams, an extra half ounce on a bat was important. I wonder how many players think that a small fraction inclination in the batter’s box or half an ounce more of weight on a bat is important.
Ted was putting so much attention to the details that he even knew -- for a fact -- that the batter’s box in Boston was a fraction higher in the back than in the front. He always felt he had a better hold of his back foot when he swung there. In Kansas City he felt the box slanted the other way, and he felt as if he was hitting uphill. He told the groundskeeper about it, and the next time he went to Kansas City, it was level. He hit two home runs that day, and when the Kansas City manager learned what had happened, he almost fired the groundskeeper! So, if you put attention to the details, you will definitely improve your battling average. Track closely your investments, and you do better than the average “batter”.
Don’t Buy IPOs
Ted Williams says in his book: “For me as a batter hitting third in the lineup, there was one thing that was 95 per cent certain: I was going to take the first pitch -- even a strike down the middle. The reason I swung on the other 5 per cent was that occasionally I got one that was so tempting, such a big balloon coming in, that I took a cut to keep the pitcher honest. I guarantee this: If you held a $50,000 home run contest for Ruth and Mantle, DiMaggio, Hornsby, Foxx or anyone else, giving each one six swings, every one of them would take a couple of pitches before they swung.”
For Ted Williams, taking the first pitch had some advantages. One advantage is that you’ve refreshed your memory of the pitcher’s speed and his delivery. You see if he’s “got it” on this particular day. You’ve given yourself a little time to get settled, to get the tempo.
The stock market works exactly this way. The IPO is that first pitch that Ted Williams is talking about. Unfortunately I learned this the hard way. On May 4, 2011. I purchased Boingo Wireless (NASDAQ:WIFI) because it was a great company that I had studied years ago. Both the business model and potential growth looked pretty good to me. Unfortunately, the stock didn’t perform as I was expecting and lost 36% of its value in just three months. I sold it on August 8, 2011 at $8, when the original price I paid was $12.50. The current PE today, as of November 21, 2011 is $86.9 which is a lot more than I would like to pay for a stock -- even if the potential growth is amazing.
Unfortunately analyst coverage, as well as the financial information on the companies, is very limited on IPOs. Investment banks tend to overvalue the stocks, making sure they and their clients make enough money even if the stock sinks. There is a reason why stakeholders cannot sell their positions within six months after the IPO. If that were allowed, I bet that most of the insiders would sell a big chunk of their positions the same day of the IPO. They know by heart that their companies are not worth the investment that bankers say it is worth.
On May 19, 2011, there was recently an IPO for Linkedin (NYSE:LNKD), one of the popular social networks these days. Value investors and fundamentalists argued that the market capitalization was absurd, pointing to the sky-high price earnings ratio (in excess of $1,000). Why would you be willing to pay such a premium for a company in an unproven market, that is generating limited profits in an ever changing industry? Why not take that first pitch and re-evaluate the company a few months or years later? Even using the most optimistic valuation methods, (read Aswath Domodoran Analysis at AAII) LinkedIn shouldn’t be priced at more than $20.94. It is currently trading at $62.56, down from $100/share at the end of the offering day.
Nobody is rushing you to buy stocks. In baseball you have three strikes However, in the stock market you can let IPOs go and go, and buy just when you know what is really happening with the stock and the company. You could have gotten Google (NASDAQ:GOOG) after a year from its IPO and still have doubled your money. Google debuted at $85 on August 19/, 2004, a year after was priced at $280. Today its value is $626.
Ted Williams used to say: “It’s simple arithmetic. You face a pitcher at least three or four times in a game. The more information you log the first time up, the better your chances the next three. The more you make him pitch, the more information you get,. Don’t hit anything you haven’t seen.”
Timing Is Everything
Ted Williams says in his book "Ground Out A Lot?," that you are probably swinging too early. Are you popping up? Probably swinging late. It’s a slight upswing, remember, and when you are late, you’re under the ball. When you’re early you’re on top.
And what about when you’re in a tight spot and a big black cloud suddenly looms above? What do you do if you are up there and things suddenly go dark?
What I did was yell "time" and step out of the box, put my finger in my eye and complain about a cinder. Unless you know for a fact that your eyes can dilate quickly enough in that split second to adjust to a light that might be half the candle power, you’d be foolish to stand in there and try to hit. Step out and wait until the cloud passes, or until your eyes have dilated and are accustomed to the new light.
If you are playing in perpetual bad light - some parks are not lit as well as others -- or don’t have as good a background, then you might think in terms of conceding to the pitcher, the same as when you have two strikes. Or maybe you’re hurt a little. It is not enough to put you out of the game, but maybe an eye problem or a sprained thumb is acting up again. Think in terms of conceding to the pitcher. Choke up. Try hitting to the middle.
Warren Buffett reduced buying stocks in 1969, 1987, and 2006, but went wild in 1950, 1974 and 1979. He just didn’t see enough opportunities when the market was overvalued, but he took great advantage when the market was down. Timing in the stock market is everything. If you are greedy and stay there more than you should, all your gains can be wiped out in a short period of time. Just as Ted Williams, learn to read the signs and take action when you can -- even if people think you are crazy!
Hundreds of people criticized Warren Buffett when he stopped buying stocks in 1999 -- and even before that. He knew most of the stock prices were speculative, but people just didn't understood how he was letting go of incredible profits from the technology sector. Well you know what happened after that...
Set Up Your Goals
In his book, "The Science of Hitting," Ted Williams said: “I’d see a guy check the scoreboard. ‘What are you looking there for? You oughta know without looking. Get in the game’.” The stock market is the same, you need to pay attention to what you are doing. It is not enough to buy and forget. You need to be on top of the game. Even big companies collapse at some point for different reasons. You need to know your goal, and when you want to get out. Peter Lynch, for instance, used to sell his Stalwarts Stocks [Coca Cola, Pfizer (NYSE:PFE)] after they had appreciated 30%. He never expected this blue chip stocks to double or triple in price -- so that was his goal, and what he did successfully for several years. You need to get in the game and commit to your own rules, Ted Williams used to say “For me, if I couldn’t hit 35 home runs, I was unhappy. If I couldn't drive in 100 runs, if I couldn’t hit at least .330, I was unhappy. Goals keep you on your toes, make you bear down, give you objectives at those times when you might otherwise be inclined to just go through the motions.”
So go ahead -- set up your goals and get in the game. You will do well if you follow Ted Williams’ advice, just as Warren Buffett did.