Probably the most widely followed stat in baseball is batting average. It measures a player’s success rate for each at-bat. Whether they get a single or a home run, a hit is a successful at-bat.
The average batting average in Major League Baseball is .250. So the average player gets a hit one out of every four at-bats. The best baseball players hit a little better than a .300 batting average. A .400 average is the holy grail that hasn’t been achieved since Ted Williams did it in 1941.
Except, in baseball, not all hits are equal. And with such a low success rate, what the player does with each at-bat becomes important. That’s where slugging percentage comes in.
Slugging percentage measures a player’s ability to hit extra-base hits. A single is one base, a double is two bases, and so on. It measures the average bases earned per at-bat which you get by taking the total number of bases earned divided by total at-bats.
So if a player wants a high slugging percentage, they need to hit doubles or better fairly often. And a high slugging percentage tends to lead to scoring runs, which is how you win games.
What does this have to do with investing?
Well, you might think the success rate (batting average) in investing is important. It seems logical that picking more winners is better. And it is.
But what matters more is how much money those winners make compared to how much the losers lose. In other words, your slugging percentage ultimately determines how successful you are at investing.
A high slugging percentage can also make up for a lower success rate. Bill Miller made this point clear in a 2006 interview:
What Earl Weaver said is that more games are won on three-run homers than on sacrifice bunts. I think that is right. Part of what people insufficiently distinguish, or confuse, is the difference between frequency and magnitude — that is, how often you’re right or wrong versus how much money you make when you’re right and how much money you lose when you’re wrong. Most people look for a high batting average — high frequency of being right. And most of the time when they do that, they have what is known in philosophy as a “high epistemic threshold.”’ They need a lot of information and a lot of stuff to convince them that they are right.
As a result, they focus on how often they are right and not on how much money they make when they are right. They might make 10 – 20 percent when they are right. But then, of course, they’ve got to reinvest. Mathematically, if they make one significant error, it will offset a lot of instances where they were right.
We focus not on our batting average, to continue the baseball metaphor, but on our slugging percentage. So, if we have a few investments where we make 5 or 10 times your money — or as we did in Dell and AOL, 50 times your money — that pays for a lot of mistakes. It pays for a lot of misses of 10 percent or 20 percent.
Now, there is nothing wrong with trying for doubles and singles in investing. It’s the cost of missing while swinging for doubles and singles that matters.
Old school Ben Graham style strategies are the epitome of a low slugging percentage strategy that works so long as you keep price and valuation front of mind with every decision to limit costly losses. But it comes with the downside of needing to swing more often.
Index investing is another example of a low slugging percentage strategy that works. An index fund might pick a stock that goes up 10x or more but that stock’s overall impact on the average return for the winners in the fund is muted because of diversification. That’s not a bad thing either once you consider how difficult it is to find and hold on to stocks that go up 10x or more. The upside is that you only have to swing once on the index fund and the fund does the rest of the swinging for you.
On the other hand, strategies that chase a higher slugging percentage might make up for larger losses but likely deal with more frequent losses too. Venture capital is the epitome of a high slugging percentage strategy.
The average venture capital firm has a lower success rate than the average baseball player’s batting average. In fact, one or two enormous winners are all it takes to offset all the losers to make a venture capital firm successful. But to do that, you need to find the next Amazon or Google or Facebook at its inception.
Of course, there are ways to earn a higher slugging percentage without taking risks like a VC. Here are just a few:
Time. Great investments don’t grow 10x or more overnight. Even holding an investment that earns a modest annual return for years will naturally boost the average of your winners. A longer holding period also removes the problem of needing to find another winner that comes with selling too often.
Risk Management. The lesson in slugging percentage is you’re bound to deal with losses. But limiting the average of your losses is one way to improve that number. The best way to do that is to avoid big losses that can really set you back.
Position Sizing. It starts with properly sizing winners and losers but it includes adding to winners or potential winners. How this is done depends on the type of strategy. For instance value strategies often add to positions on declines, lowering the average cost basis, which boosts potential future returns.
Turnover/Rebalancing. Investors often want to hang on to losers and sell winners but the old adage of cutting your losers and letting your winners run certainly applies to a high slugging percentage. From a broad portfolio perspective, applying strategic rebalancing rules that take advantage of corrections and crashes can boost potential future returns too.
Behavior. The market rarely makes it easy to earn great returns. And it’s impossible to earn a high slugging percentage in investing if you’re scared out of great investments. So the ability to hold on, especially during rough patches, is key.
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