The Men’s Division I Basketball Tournament is often considered one of the best sports tournaments in the U.S. After four preliminary games are played, 64 teams face off in a riveting single-elimination tournament that draws fans of all country.
It has size, dislikes, drama, Cinderella stories, heartbreak, heroes and villains. And it’s all over in less than three weeks.
In 2014, the legendary investor and the CEO of Berkshire HathawayWarren Buffett announced that he would pay $1 billion to anyone who made the perfect tournament bracket, which involves correctly predicting the outcome of each game. It is a simple but almost impossible challenge.
Since then, Buffett has continued the tradition and added smaller prizes to select the correct winners from the first or second round of the tournament. This is what makes the support challenge so difficult and, more importantly, what it can teach us about long-term investing.
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almost impossible odds
The first round of the tournament consists of the top 64 teams in the country divided into four different geographic regions: the West, East, South and Midwest. The teams in each regional group are ranked, or “seeded”, from 1 to 16.
For the second round, only 32 teams remain, followed by the regional semi-final, regional finals, national semi-finals, and then the championship game. In total, there are 63 games.
Flipping a coin to predict the winner of each game is one way to fill up a pool. The odds of getting it right would be two to the power of 63, or 1 in 9.22 quintillion. If you chose the top seed to win each matchup, such as the No. 1 seed beating the No. 16 seed, the No. 2 seed beating the No. 15 seed, and so on, your odds would improve. But historical data suggests it would still have only a 1 in 46.58 billion chance of a perfect group. These nearly impossible odds illustrate why Buffett is so confident that no one will pick a perfect group.
Lesson No. 1: The market is wrong all the time
The experts who seed each team before the tournament begins are like Wall Street analysts who know the ins and outs of a company. However, even the experts are wrong.
According to tournament data, the No. 10 seed beats the No. 7 seed in the first round almost 40% of the time. Even the No. 14 seed beats the No. 3 seed 15% of the time in the first round.
Upset in the first round
No. 10 seed beats No. 7 seed
No. 11 seed beats No. 6 seed
No. 12 seed beats No. 5 seed
The No. 13 seed beats the No. 4 seed
No. 14 seed beats No. 3 seed
No. 15 seed beats No. 2 seed
The No. 16 seed beats the No. 1 seed
The lesson here is that surprises happen all the time. in the case of the S&P 500, there are 2,000 quarterly earnings calls in a year, far more iterations than the 63 games of the Men’s Division I Basketball Tournament. The chances of a single shocking surprise may be small. But when the sample size is so large, there is a high probability that several major companies will report news that no one saw coming.
The price of a stock is essentially the market’s consensus estimate of what the company is worth at any given time on any given day. And like tournament seeding, that estimate is often overly optimistic or grossly underestimates what a team or company could be worth over time.
lesson no. Myth #2: Black Swans are always unexpected and never the same
In 2018, the No. 16 seed University of Maryland, Baltimore County Retrievers beat the No. 1 seed Virginia Cavaliers in the first round. And they didn’t just get a win. They won by a decisive margin of 20 points. It was the first and only time a No. 16 seed had beaten a No. 1 seed in tournament history.
Statistically speaking, the upset was a black swan for the Cavaliers, and nothing short of a miracle for the Retrievers. Don’t feel bad for the Cavaliers though. They would go on to win the entire tournament the next year in 2019.
Every upheaval is different, just as no recession is the same. The economy in general was caught off guard by the COVID-19 pandemic, as was the financial crisis, the bursting of the dot-com bubble, the oil crash of the early 1980s, etc. The lesson here is not to react strongly to surprises or blame bad luck when they occur. Rather, surprises are simply par for the course when it comes to investing. Writing with a degree of randomness will help keep your emotions in check during a stock market selloff and set realistic expectations so you know when a company is overvalued.
Lesson #3: Titans Fall
Just as unlikely underdogs can unseat highly favored winners, so too can smaller companies emerge and become more valuable than the industry leaders of yesterday. In 2012, International business machines it was the fourth most valuable US corporation by market capitalization. Today, just 10 years later, it is the 71st largest company in the US by market capitalization. Times change, new companies emerge and old ones fall. The best we can do as investors is to be right and adapt to the changing economy.
Lesson No. 4: Failure is inevitable
The Men’s Division I Basketball Tournament teaches us that not even the favorites get the results they expect each year. Investing also has good and bad seasons, also known as market volatility. It’s nearly impossible to beat the market every year, let alone have every company in your portfolio report a good quarterly earnings report. Investing, at its core, is about finding companies that you think will grow over time, not expecting every deal to pan out.
Lesson No. 5: Focus on long-term success
Sports teams try to build a good program by recruiting talented players, practicing disciplined training, and executing good training. Similarly, an investor should try to pick good companies, while also maintaining composure when the stakes are high.
When the lights shine brightest, it is not the investor who picks the best stocks that gets the best results, but the investor who picks good or even acceptable stocks, but has the temperament to be disciplined and calm. Having the conviction to survive market volatility and the patience to let your investments accumulate over time are keys to successful investing.
After all, what good is having the most talented basketball team if panic breaks out during the critical moment? Or, in the case of investing, what’s the point of picking good stocks if you sell them too soon before giving the investment thesis a chance to develop?
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