3 Stock-Picking Lessons From March Madness

by James Brumley | March 28, 2013 8:25 am

3 Stock-Picking Lessons From March Madness

For basketball fans, this is one of the most exciting times of the year. By the end of this weekend, the NCAA will have narrowed down its Division 1 men’s basketball tournament survivors to the Elite Eight.

It’s great to see these players rise to the occasion, demonstrating an amazing amount of skill along the way. Indeed, simply watching these games can be an object lesson for all of us — not just in terms of how to play the game, but how to handicap the tournament’s dark horses as well as spot the pretenders.

These also are lessons that can be applied to stock picking. Sometimes stocks don’t end up performing as well as you expect (like #2 Georgetown’s first-round loss), while others end up pleasantly surprising you (#14 Harvard over #3 New Mexico).

On the other hand, sometimes stocks perform exactly like they should, like the three #1 seeds still alive in this year’s tournament.

In retrospect, however, there’s been nothing downright shocking about the way the men’s tourney has unfurled; any of the wins or losses could have been predicted by someone savvy enough to see what others were overlooking.

With that in mind, here are three lessons that apply to picking stocks as well as picking basketball teams.

Sometimes, Think Small

While all the schools represented in this year’s men’s D1 tournament are sizable, some are much bigger than others. Generally speaking, the biggest schools tend to get the best seeds and have the most prolific programs.

Take Kansas University, for instance. The school — a #1 seed in the tournament — boasts an enrollment of 25,000, and is a perennial powerhouse.

Meanwhile, Butler University — a 4,000-student school — was a relatively obscure #6 seed that lost to Marquette in the second round. Still, with a student base of that size, Butler is defying the odds just by being a tournament regular.

Even more impressive is that this little school made it to the championship game in 2010, losing to another dominant program, Duke. And in 2011, Butler made it to the championship game again, only to lose to Connecticut. It was never given better than a #5 seed either time, and it went toe-to-toe with some of the best programs in the country.

Translating that lesson to stock trading: Most small-cap winners are the proverbial diamonds in the rough, and worth the work of digging up. Butler probably busted up a lot of brackets, but the few people who really put Butler University under the microscope knew it had Cinderella story potential.

Don’t Take the Professionals’ Word for It

You know how many times a #1 seed has won the NCAA men’s basketball tournament? Only 17 times in the past 28 years. In other words, in 11 of the past 28 years, a non-#1 seed was the tournament champion.

That’s not an impressive track record, especially considering there are four #1 seeds each time the tournament is played … four chances for a #1 seed to win the whole thing. The folks doing the seeding are supposed to be the experts, right?

Translating that lesson to stock trading: Analysts’ track records at picking stocks are about as spotty as the selection committee’s ability to rank basketball teams. You’re better off doing your own due diligence, and picking your own stocks regardless of analyst ratings.

Consider the Competition

While the tournament selection committee aims to make all four branches of the tournament bracket as evenly matched as possible, the reality of the matter is that some brackets are less competitive than others. This year’s West regional bracket, for instance, is an amazingly tough one

The bracket started out with Gonzaga, Wisconsin and Ohio State, each of which has a stellar season. Indeed, any of the West’s top ten seeds is (or was) capable of competing against any team in the country … that can’t be said for the other three brackets.

If you need proof, just look at #1 seed Gonzaga. The team was surprisingly knocked out by #9 seed Wichita State in the tournament’s second round.

Translating that lesson to stock trading: While there are no head-to-head competitions for stocks, there are proverbial brackets, like sectors or industries. Compare telecom to technology as an example. While a telecom name like AT&T (NYSE:T[1]) or Verizon (NYSE:VZ[2]) could never grow as quickly as a Google (NASDAQ:GOOG[3]) or an Apple (NASDAQ:AAPL[4]), if AT&T or Verizon can still grow the bottom line at an annual pace of 6% or more, that’s still tops within the telecom industry.

While every name in the tech sector could potentially outpace every name in the telecom sector, it’s simply unwise to invest all your money into one arena. It would be like betting on every name in just one of the tournament’s four brackets to win the whole thing — you’ve guaranteed yourself a lot of disappointment, yet you’ve still not guaranteed yourself a championship winner.

The Last Word

These are three simple ideas that apply to basketball as well as trading. Just consider it as something to think about this weekend and next weekend as we narrow the field down to one winner.

Oh, and for what it’s worth, Louisville is going to take it all.

As of this writing James Brumley did not have a position in any of the aforementioned securities, nor did he have a financial interest in the outcome of the NCAA men’s basketball tournament.

Endnotes:
  1. T: http://studio-5.financialcontent.com/investplace/quote?Symbol=T
  2. VZ: http://studio-5.financialcontent.com/investplace/quote?Symbol=VZ
  3. GOOG: http://studio-5.financialcontent.com/investplace/quote?Symbol=GOOG
  4. AAPL: http://studio-5.financialcontent.com/investplace/quote?Symbol=AAPL

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