Ideas Farm: The NBA's lessons for investors

The NBA season is drawing to another enthralling conclusion. This might mean little to non-basketball fans. But whether you believe the Golden State Warriors are on course for another championship or have never even heard of the Miami Heat, the sport’s premier league has plenty of lessons for investors (see page 14 for more on the overlaps between sport and investing).

One place to start with is focus. To a greater degree than most team sports, NBA coverage is framed around its superstars; those players who score 40 points a night and make the game-winning shot from 25 feet. In some instances, this is understandable: with just five players on the court, each team depends more on the contribution of their playmaker than, say, football or rugby.

Just as markets are often in hoc to wonder stocks or today’s winning investment strategy, basketball is sometimes presented as a battle of the most valuable players – rather than the combined talents of a squad.

This is another way to say that concentration risk and diversification matter just as much to basketball teams as they do to investor portfolios. The teams likely to contest this year’s NBA championship finals - the Warriors, and either the Heat or the Boston Celtics – look more rounded than many of the star-studded sides they have felled in recent weeks. Each has its fair share of brilliant players, but none have been called on to single-handedly carry their teams.

Similarly, investors should never lose sight of how their asset allocation decisions serve their goals.

“Once you’re in the league six, seven years, you realise that numbers aren’t that important,” the now-retired former Warriors centre Andrew Bogut said in 2015. “You get the ‘W’ [win], that’s more important. No-one’s really going to talk about a guy who averaged 20 and 10 [points and assists] on a team that’s terrible.”

This gets to the heart of another parallel. In investing, big numbers – in the form of share price spikes and crashes, early-stage sales growth, or adjusted profits – can be equally deceptive, and don’t always translate into what matters, which is the prospect of long-term cash generation.

Indeed, financial and sporting metrics ultimately do matter. NBA managers look to turn talent into consistent positive point differentials, and investors aim to turn capital into profit. Both require proper due diligence and attention to margins, ratios and capability.

This helps to explain why both worlds have seen an explosion in data analytics in recent decades, as investors and basketball franchises have sought to exploit any market edge. At the same time, the proliferation of data and data users in both fields has resulted in diminishing returns from those slight informational advantages.

For all the tactics in the world, any basketball fan will freely admit to the outsized role luck can play in a single game, and a team’s longer-term success.

Injury is one obvious example. Another is the college draft system, which while designed to prop up competition, can make or break an NBA franchise. From 2007 to 2009, Oklahoma City Thunder landed three of the greatest ever players in succession, in Kevin Durant, Russell Westbrook and James Harden – without knowing each would prove to be all-star players. Zion Williamson, hailed as a generational talent while at Duke University, has so far proved a disappointment since the New Orleans Pelicans selected him as first pick in the 2019 draft.

But as with investing, hoping for good luck is not a strategy. Great teams, like great investors, tend to put a dedicated process or set of principles first – and in the knowledge that ultimate success (be it beating the market every year, or capturing a championship) is statistically unlikely.

This doesn’t mean settling for average. Winning matters. But accepting losses, and still hanging in there for the long haul, probably matters more.

Further reading:

Chasing Perfection: A Behind-the-Scenes Look at the High-Stakes Game of Creating an NBA Champion (Andy Glockner)