“No one has ever bet enough on a winning horse.” Proverb
It’s that time of year again!! Time for “The Greatest 2 Minutes in Sports” – The Kentucky Derby. If you find yourself in Louisville during the first Saturday in May, you know that everything in this city revolves around horses, bourbon, hats and betting. Lots and lots of betting.
Part science, part art, and lots of luck make for good betting practices. For me, I can’t help but think of the similarities between betting on horses and betting on companies. Just like betting on horses, being an angel investor is a little bit of science, some art and a bunch of luck when investing in companies. When we began to venture into the world of angel investing, we were surprised to learn that only 1 out of 8 deals actually pay off. Data collected by the Kauffman Foundation shows that the odds of a positive return are less than 50%. The upside is that when an angel investor picks a winning company, the returns average 2.5 times their investment.
With odds like this, picking a winning investment can be a lot like picking a Derby winner. Just for fun, I decided to apply the science of horse betting to the art of investing. Here are my picks:
- Read the racing form. Every track will publish a racing form for each race. On the racing form you will find all kinds of information about both the horse and the jockey. Consider this your due diligence. Just like reading a business plan, P&L statement or a balance sheet, you have to know what you are looking at and which stats are most important to you. Investing requires you to study the industry, understand the company potential, and understand how the company may perform in certain situations. This is how a racing form is like a prospectus.
There are little details on the racing form that will tell you what type of race is running, how the horse compares to the competition, extenuating factors that may influence outcomes and insight on how everyone else perceives the value of the horse in comparison to the others in the race. To the untrained eye, racing forms can be complicated and overwhelming. If you are unsure how to read the information provided, seek out expert advice.
- Pay attention to the owner, jockey & the trainer. Think of these roles as the executive team for a startup. The owner has invested money into the horse and either has a reputation for picking winners or losers. They either have experience in the industry or not. The trainer gets the horse ready for the race, making sure it is in tip-top shape. The jockey is in control the day of the race. They are the one who will ultimately get the horse over the finish line beating out all of the other entrants. Their track record can be equally important to the horse’s. Just like a CEO, they have to maneuver the horse through whatever comes their way.
- Pay attention to the odds. When it comes to betting on a race, there is no such thing as a sure bet. But one thing is for sure, everyone wants to pick a winner. You can choose to bet on the favorite or risk your cash on a longshot. The odds, as they are called, help you understand the potential risk. The lower the odds the safer the bet. For example 2-1 means that for every dollar you bet you will get $2 back. Higher odds translate into higher risk with bigger payoffs. When evaluating a potential investment similar concepts apply starting with the valuation. Just like betting on horses you have to know how much you are willing to lose and how much risk you can afford to take.
- Pay attention to your instincts. At the end of the day sometimes the best bets are made based upon the number, the name of the horse, their silks or the color of the horse. A favorite angel investor told me one time that she can feel it just like an itch. The investment can look fantastic on paper and they may have an all-star team in place but if she doesn’t feel “it” she will not invest her money.
Hopefully this Derby weekend you will pick a winner. If you can’t make up your mind who to pick, wait until the next race. Sometimes it’s the bet you don’t place that are the biggest winners for the day.