My friends at Buckingham Asset Management in St. Louis like to mix sports with investments. Invariably, they set up an analogy that proves itself quite accurate. For example, they talked recently about a point spread citing the 2001 NFL champion St. Louis Rams. They said that if the team were playing a weaker opponent, there might be a 20-point spread to bet on them. Accordingly, for the bet to pay off, the Rams would not only have to win, but would have to do so by more than 20 points. Note that the initial point spread is set by the market (not the bookies) that determines its direction. On Monday morning, the spread might be set at 15 points but if this brings in more betting on the Rams than on their opponent, the spread would widen until supply and demand equalize.
Stock prices are set along the same lines. An investor might pay $30 for each dollar of earnings (or perhaps 10 times book value) for a certain high-flying stock while paying just $7 for each dollar of earnings for a distressed value company. And keep in mind that fund managers and stockbrokers, just like bookies (who also don’t gamble their own money), get paid, no matter whether you win or lose.
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