As we are in early August, we are one month away from the start of the NFL season. That means that millions of people will again be building their fantasy football teams, and I will be one of them. While not all of those reading this article will be familiar with how fantasy football works, I'll try to explain certain parts throughout this article. Today, I'm going to explain how you can build a stock portfolio using similar techniques to building your fantasy football team. I'll throw in some stocks as well to illustrate my point.
Rule 1 - Diversification is Key:
In fantasy football, you probably don't want to build a team that consists of players from the same team. For example, if you build a team composed entirely of players from the New York Jets, and they have a bad year offensively, you are done in your league. You usually try to spread your players from 5-10 teams in the NFL (or more, depending on how many players you need). That way, if one team has a down year, it doesn't affect all of your players.
When you build a stock portfolio, you generally are looking for a couple of things. First, you are looking to make money. Second, you generally are trying to reduce your overall risk. So how do you do that? Well, generally speaking, the more names you own across various sectors, the less total risk you will have. It wouldn't be a wise decision to only own financial names, because as we have seen, that can have disastrous effects.
When building your portfolio, think about it this way. If you have $100 to spend on your fantasy football team, of say 15 players, that's an average of $6.67 to spend per player. If you're building a stock portfolio of $10,000 with 15 stocks, it's an average stock purchase of $666.67. You'll put more money into some names, and less into others most likely, as you probably will favor certain holdings over other ones.
Rule 2 - Pay attention to valuations:
In fantasy football, there are two types of drafts. Regular drafts go back and forth. In a 10 team league, Team 1 gets first pick in round 1, but gets last pick in round 2, and first in round 3 and so on. Team 10 would get last pick in round 1, but first pick in round two, and so on. When it's your turn to pick, you can pick any player that hasn't been picked already.
The second type is an auction draft. In this type of draft, a player is nominated, and that is the player currently available. Any team manager can bid on that player, and like a usual auction, whoever has the highest bid in the end gets that player. In this draft, you can get any player at any time, but for a price, and you have a limited budget, so you have to spend wisely.
So for this example, let's use a real life example. Matthew Stafford is the quarterback of the Detroit Lions. He had a tremendous year in 2011, but in the two years prior, he was hurt a lot and only played 13 total games out of 32. In Yahoo! auction leagues, teams are paying an average of $30.40 for Stafford. On the other hand, we have Tom Brady, quarterback of the New England Patriots. Brady, except for one year when he was hurt, has been a top level quarterback for the past decade. He is one of the older quarterbacks in the league, but is on one of the best teams, and with him, you know that unless he gets hurt (which is possible with everyone), you are getting a top tier player. Brady is fetching an average of $37.20 in leagues right now, or a 22.4% premium to Stafford.
So is the premium worth it? I say it is. But think about it this way. Let's compare Apple (NASDAQ:AAPL) to Cisco (NASDAQ:CSCO). When using GAAP earnings, Apple is trading at a 19.53% premium (on a trailing 12 month P/E basis) to Cisco. Would you pay a 19.53% premium to own Apple instead of Cisco? Right now, I think you would. Apple has two of the hottest products on the planet, and is basically Tom Brady. Cisco has had some rough periods over the last couple of years, and is a question mark like Stafford. When picking your team, you pay attention to valuations, and you should also do it when buying your stocks.
Remember what I said before about putting more into certain holdings? Well, in Yahoo standard auction drafts (10 teams, $260 budget), the top 10 players are going for an average of about 17% of that budget, meaning teams are putting roughly 17% of their team budget into their top pick. That seems logical for a stock portfolio too, with 17% in your top holding. Likewise, the next 10 players are going for about 13% of the total, meaning 30% for your top 2. I think that most investors would say 30% for their top 2 holdings might be a decent starting point for any portfolio.
Rule 3 - You Need a Stud:
When it comes to fantasy football, you need to have that one player that just dominates the game. Having that one top guy, whether it is a star quarterback like Aaron Rodgers, Tom Brady, or Drew Brees, or even a top running back, like Arian Foster, Ray Rice, or Adrian Peterson, you want a guy you know that over the season, will score you a ton of points.
Don't you want a stock like that? One that can return a nice profit? If you asked 100 people the "one stock to own", I'm assuming that Apple would be that stud investment. But if everyone owns Apple, then everyone will have the same performance. You need a stud that may not be as well known.
I'll give you one here, Intuitive Surgical (NASDAQ:ISRG). This company makes the da Vinci system, which is a surgical robot system. The company sells the robots, along with plenty of accessories. But beyond that, this is a name expected to grow revenues at about a 20% pace combined for this year and next. It also has very little competition, and actually is partnering with large names such as Johnson and Johnson (NYSE:JNJ) in certain countries. The company boasts very high margins, has no debt, has more cash on its balance sheet than it has total liabilities, and is currently buying back stock. It also has dropped since its last earnings report, where it blew out estimates again, and that provides a tremendous buying opportunity. This may be the non-Apple stud you are looking for.
Rule 4 - Look for Values:
In fantasy football, after the first couple rounds of your draft, all of the top tier players will be gone. When you start getting into the middle rounds of the draft, you need to look for good players at the right price, or at the right spot (for regular drafts). A good example this year is Michael Turner, a running back for the Atlanta Falcons. This guy has been tremendous in recent years. In the past five years, he has missed five total games, all in the same season. Over those five years, he has been a top 5 running back in the entire league. This year, he's being drafted as the 15th best running back. Of the 14 going ahead of him, one is an unproven rookie, and 7 missed at least three games last year (out of 16), with most of those injured players coming off knee surgeries. When you have a guy that should up in the top 5-10 spots for running backs going as the 15th, that is a good value.
So how about a good value stock? Well, how about Philip Morris (NYSE:PM)? This stock has a 3.35% annual dividend, which is expected to be raised in the next few months. The company plans to buy back $6 billion in stock this year, and a similar amount per year in the next 2-3 years. The company is an analyst favorite and has been a great name to own since it split off a few years ago. The company is still going strong, and I would advise buying on any pull backs.
Rule 5 - A little speculation is not a bad thing:
In investing, the general theory is no risk, no reward. You can't make any money if you don't risk any. Well, fantasy football is no different. Sometimes, you just have to take a little risk. Whether it is paying an extra couple bucks for that rookie who you think could be a star, or drafting an unknown player who could help you win the championship. A good example last year was Victor Cruz, wide receiver for the New York Giants. Going into the season, he was the 3rd or 4th best receiver on the team, so in many fantasy football leagues, he wasn't even drafted. In my one league, I didn't pick him up until after the 3rd week of the season (there are 17 weeks, 16 games played with one bye week for each team). What did Cruz end up doing? Well, he became one of the league's brightest stars and scored the 4th most points among all wide receivers. Including all offensive players at every position, he was ranked as the 21st best player in the entire National Football League. All for a guy who was barely drafted in any league, and in some cases, not even picked up after the first few games.
So in the investment arena, it's okay to risk a small portion of your portfolio on a speculative name or two. Sure, these names could easily lose all their value, but over a couple of years, they could also return several hundred percent. I've provided a couple of names that could fit this category, some as trades and some as long term investments. Dendreon (NASDAQ:DNDN) is a great example. This is a biotech firm that makes a prostate cancer treatment called Provenge. Provenge sales are increasing rapidly over prior year periods, although the growth has been slightly disappointing in recent quarters. Dendreon trades for less than $5 now, and was in the mid $40s at one point last year. This is a good all or nothing name to be in. You'll either lose everything over the next couple of years, or Dendreon will return you several hundred percent.
Like I said, I wouldn't bet the farm on any of these names, including Dendreon, but having a small piece of speculation in your portfolio isn't really a bad idea.
Conclusion - Similarities do exist:
You might not really think that fantasy football can be applied to investing, but it surely can be. I probably could come up with five more rules if I wanted to, but I think I've made my point. For those out there about to start building your fantasy football team or a stock portfolio good luck, and remember, if you've never done one or the other before, you can apply one's concepts to the others.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ISRG over the next 72 hours.