Financial Statements and Baseball Statistics
Apr 14th, 2008 by Nut
So I’ve written before about my idea to churn out some kind of robust analogy between baseball statistics and financial statements. The reason is twofold: the analysis that baseball fans like myself do every day with baseball numbers is pretty involved—this isn’t simply looking at batting average and homeruns. It’s pretty sophisticated stuff and the fact that so many people who don’t know “anything” about investing find it too complex to try to learn makes me feel like there’s an opportunity there to say, “Listen, you do this kind of stuff already. You are capable of figuring out if a company is in good shape or not. We just have to draw some analogies to help you out.”
The second reason is because I’ve been wanting to learn how to read financial statements for a while now. I’ve tried the standard way by reading books about it, but it’s just too dry and too boring. But I still want to learn to read financial statements, so I’m trying to use my baseball analysis skills to find a way to make the whole thing more entertaining.
Yesterday it hit me that the ultimate goal is to be able to take three unknown companies and—using only their financial statements—be able to tell which one is in better financial condition.
It would be like having statistics for three unknown players and having to pick out which one is “better.” Of course “better” is totally subjective since some people think one statistic is more valuable than another, but the idea holds in both investing and sports, I think. For example, if I was told that I would need to pick which player is “better” based only on three statistical numbers, which numbers would I pick? For me, it’s simple: OBP, HRs, and RBIs. It may not sound very elaborate considering the bevy of “new” statistical methods out there, but in my mind these are the most important numbers. That’s why players like Albert Pujols, Barry Bonds*, and David Ortiz are so valuable in my eyes.
But back to the analogy to the world of financial statements. Here’s what I came up with yesterday as I was trying to figure out which stats are the most important in both baseball and the world of finance. How many times have you heard the phrase “earnings drive stock prices“? I believe it and based on that I came up with this:
Earnings is to stock price as runs are to winning/losing
The most important thing in both investing and playing baseball is the stock price going up or down and winning and losing, respectively. And the both of these things, while being driven by several factors, can be culled down to one main attribute: earnings and runs. The more runs you score, the better your chances are to win. If you don’t score runs, you can’t win the game. If, as a business, you can increase your earnings consistently, your stock price will improve.
Are there other factors to consider besides just earnings (for investing) and runs (for baseball)? Of course there are! If only these two topics were that simple! But if you love baseball and don’t “get” investing, it’s a realization that might help you put it all in perspective. Into a language you can understand.
There are many ways to score runs and there are many ways to increase earnings (I’ll try to tackle that another time), but I think it’s a great starting point as I push deeper and deeper into this analogy. It’s going to get more and more complex, but I’ll do my best to continue making it simple and understandable (for my benefit and yours).
For the people out there who know financial statements and are pros at reading them, what do you think? Any outright errors in my work here? Any suggestions for further analogies down the road?
Open an ING account and get a $25 bonus!
There’s no doubt that earnings are definitely a major player when analyzing companies. Unfortunately, as you said, it isn’t as simple as just looking at earnings. Cash flow is another important statistic that should be looked at in conjunction with earnings. A company may have great earnings but poor collections. If they aren’t collecting on the receivables they are generating, they could be in big trouble.
A company can also have great cash flow because they are heavily leveraged on capital assets and a lot of the cash flow comes from depreciating those assets. Depending on your investment preferences and the company you are analyzing, high leverage may or may not be a concern. You can see what sort of leverage the company has on capital assets and long-term debt by reviewing the balance sheet. Cash flow can also be improved by issuing stock or increasing debt. Again, the balance sheet will tell the story there as well. Although it isn’t a single statistic, I think the balance sheet is the most important financial statement. It is the scorecard and the income statement and cash flow statement are essentially derivatives of the balance sheet.
[…] Writer’s Coin writes about the similarities between financial statements and baseball statistics. I’m going to have to have a little side conversation with him about the value of RBIs as a […]
[…] hosted over at Lazy Man and Money. The article of mine that was included was a piece I wrote on the similarities between financial statements and baseball statistics. Lazy and I will have a discussion on how […]