Dear fellow investors,
My father and I both attended a small liberal arts college that was one of the strongest academic institutions in its region and was tough to get into. While it sat far away from the amenities of a large city and was historically weak in sports, it produced a lot of success out of its powerful educational rigor. It was also highly likely for you to marry someone you went to school with. The paradox that this marriage potential created at the college was that the odds are good, but the goods are odd. This is the statement that can be made for common stock investing today.
Understanding the Odds
Gamblers are provided odds on wagers because the future is unknown, but bettors have perceived favorites. The bookmaker in any race or competition adjusts their odds on each outcome to balance the books, so they don’t lose money. They want to accept enough bets that they collect a spread on the winner and losers. It doesn’t always play out like this, but this is how it works in an ideal world. The favorite isn’t always the winner. It’s just the most likely winner based on the bets that are placed. The future stays unknown.
A great example of this was a Kentucky Derby party that my wife and I were invited to. We were told to bring cash to place our bets. When we arrived, I found that there were no odds being given on the horses at the party. You got paid the same for the horses that were least likely to be bet on as you did for the horses most likely to be bet on. In a world without odds, there is only one answer. You bet the favorites as you don’t get compensated for taking extra risks. I bet what I saw at the time were the top four favorites to win (and advised others to do so as well). You got paid for the win, place, and show. At the end of the race, I didn’t pick the winner (Mage), who was a long-shot winner, but two of the heavier favorites that I bet on, Two Phils and Angel of Empire, took 2nd and 3rd. Based on the money in the pot, I made 10% on my bets, which was fine by me.