What Can Investors Learn from Sports Betting?

Welcome to "The Informed Investor," where we break down the latest financial headlines, bringing in research and insights to help you separate the news from the noise. Welcome to "The Informed Investor," a show brought to you by Dimensional Fund Advisors, a global asset manager known for bringing financial science to investing. Today's topic is sports betting and its parallels to financial markets. I'm Mark Gochnour, and I'll be joined today by Wes Crill and Jake DeKinder. And to set up the show today, we got our favorite sports gear on. You've got football represented, you got some baseball represented. I got Boise State Broncos, my all-time favorite college football team. And I love this topic today. How does the market set prices across all kinds of different venues, shopping, the market? Well, it's all supply and demand. You know, for a given price, if there's a lot more demand at that price, the price naturally goes up, and supply will adjust accordingly, depending on what prices are as well. And that's a function of the super market. It could be a function of stocks and bond pricing. It could be a function of sports betting. There's a whole bunch of different ways that that manifests itself. Absolutely. And what you mentioned, supply and demand, these are forces that push the market toward an equilibrium. You know, where you have half of the people thinking a price is too high, half of the people thinking a price is too low. And then that's where they meet in the middle. Well, let's also realize that that equilibrium price can adjust, and does adjust, on a regular basis, and why? Because of new information. You know, you go back to sort of like the supply and demand for goods. I mean, we were joking beforehand that if there's something that happens with the crop of avocados, and the demand for avocados remains the same, but the supply shrinks up, what's probably gonna happen? The price is gonna go up, right? So it's not just sort of this random, arbitrary. It's everybody's processing that information. And then where that equilibrium price lands is how everybody sort of expresses their view. And, again, it's just that supply and demand, and it's gonna adjust. Another example of markets gets into the sports betting world. So let me read you a couple headlines around that, and then I'll get your thoughts. So the first one, The Surprising Truth: Why Is sports betting so hard?" And the second one, are sports betting markets efficient? So a great way to introduce a topic to you of how markets are working in that environment as well. In both of those, I think you would tie to equilibrium markets, and the equilibrium markets are very difficult to outguess, and they're largely informationally efficient. So that makes sense. I love the fact that they just use the term efficient. I really enjoy that. They're doing our work for us. They really are. The gospel's being spread, it's great. One investor at a time. It's a really good analogy just for how prices get set. You know, how markets reach the equilibrium. And, again, you go back to the idea of supply and demand. Okay, let's think about if I am a casino and I'm trying to run a successful sports book, well, my ultimate goal at the end of the day is to get half the money on one side of a bet, and half the money on the other because I want them to basically cancel each other out. And so the the point spread that we often talk about when it comes to betting on games, that's gonna move around to help balance that supply and demand. And I think that's sort of a fascinating concept. It has a lot of ramifications that would apply to financial markets as well. And that's really the market at work. You know, we talked a lot about we will see some of these different games, sports bets at the end of the game. Like, man, those guys are good. Like, like they just got it right on what the line was. The outcome was so close to the actual spread. But it's not just somebody sitting back in an office coming up with that. It's the market. And going back to supply and demand, the market effectively is the one determining that spread. So you get equal dollars on both sides, the better of both teams I should say. And it's dynamic to your point earlier, which is like, okay, if a star quarterback gets hurt during the course of the week before the game, what's the line gonna do? What's gonna move to accommodate that? Because whatever the information, the expectations were before, that set the line, those are no longer relevant, or relevant, but no longer fixed. No, exactly. It's the adjusting based on new information. I do also find it funny, you know, you may have a game that's coming up for the weekend and, you know, you talk to people and they're like, oh, that spread's completely off. I'm taking X, Y, Z team, right? And you're like, wait, now you're literally just almost getting into the stock picker mentality, which is prices are wrong, and I somehow know more, and clearly this is what I need to do. And more often than not, if people go down that path with betting, you can lose a fair amount of money. And, listen, the reality is that when you try to outguess markets, it's really, really challenging to do, yet people keep trying to do it. Well, it's funny you say that. The ones that seem the most obvious were like, that line is so outta whack or, you know, this company seems like such an obvious buy. Those are the ones that I've always gotten wrong. The worst. Oh, the obvious buy one. That's actually a great point. I mean, how many people do you talk to that they're like, oh, I just know X, Y, and Z company is underpriced. And you're like, wait. So there's hundreds of millions of dollars, billions of dollars, hundreds of billions of dollars trading hands every day, sort of setting these equilibrium prices that we're talking about. And somehow, you know more than the market. It's crazy when people make those comments. Well, on all known information is available in those prices, whether it's a stock or bond, or go back to some of the sports betting, that spread, for example. It takes into account whether it might be obviously a home field, the injury status, you mentioned that one before. I've got a couple examples here of that from a game I went to earlier this year. So let me get my numbers here, make sure I've got this right. Okay, so I'm a big Boise State fan, hence my Boise State jersey here today. So we went to the Boise State at Notre Dame game. And the line before the game, it was 21.5 points. Notre Dame was the favorite. The actual outcome, Notre Dame won by 21. And that's where you're just like, man, it's just spot on, you know. It doesn't have to be that way, right? Like, these point spreads are not literally exactly what people think is gonna be the ultimate margin for the game. It's just whatever it took to balance out those two different sides. It's a good point though, right? It's not saying that it's perfect, it's fair. It's balancing out the two sides. And a lot of times when we talk about markets, market prices, we never say it's the correct price. So that it's a fair price based on all relevant information and all buyers and sellers coming to the market to express their opinion. It doesn't mean that that is the correct price. In fact, nobody knows what the correct price of a stock is. The question is should you act as though that might be the correct price or a fair price versus trying to out guess it? Let me give you another example. So this is another Boise State game from this year. This was a couple weeks later. Boise State was playing Fresno State. In this case, they were a favorite, 17 1/2 point favorite, and they ended up losing by 23 points. So a complete opposite outcome. But a lot of times, we talk about unexpected events, and in this case, the quarterback got hurt. Boise State's quarterback got hurt first quarter, and then they just couldn't generate any offense and lost the game. So those things happen as well. Unexpected events, which, I guess, you know, it certainly impacts the outcome, it impacts expected returns and things like that. But kinda like an investor, those things happen. Well, I mean, let's think about the last couple of years, right? I mean, we've heard a lot about different sectors, really one sector in particular in the market that's been doing really well. And I think people sort of say like, well, what happened there? And one of the things that we talked about is that that was an unexpected outcome for those types of stocks. It doesn't mean that it can't happen, it's just you formed appropriate expectations. But there will be unexpected outcomes in life, in markets, in really everything. Yeah, and I think the key implication with a fair price is that no one has an unfair advantage in terms of predicting which way that's gonna go. So if that's the case, you would probably expect your chances of doing better than the market or out picking, you know, the favorites in a sports game to be like 50/50. And that's almost exactly what we've seen historically. There was an academic study that looked at the frequency with which favorites won in the NFL and in the NBA, and it was 48% of the time the favorite won against the spread in the NFL, 49% for for NBA teams against the spread. And these are samples of like five, six, 7,000 games. So that's exactly what you would expect out of a fair price. And I think you have to be careful when you get the unexpected outcome, does that mean you should change up your expectations going forward? And if you know whatever game you cited there, where you basically had a massive favorite, and then they ended up losing the game, right? Those things, but it doesn't mean that if you were going to look at a future spread between two teams that you should somehow then say, well, that one's completely wrong because you had an unexpected outcome. It's the same thing with investing. When you encounter those unexpected outcomes, just be careful changing up your expectations based on that one event or that couple of events. Really well said. And I wanna go back and just clarify a point here. When we talk about expected returns, again, we're separating. We're just talking about marketing. Returns from sports betting versus investing. You're doing a great job on compliance side. Well, the expected returns should be probably negative for gambling, right? Like, you go in assuming the house is going to take your money, whereas with stocks and bonds and things like that, your expected return is positive. So, yeah, very clear distinction. I think sometimes it's becoming fashionable to sort of use those terms interchangeably, like gambling and investing, and they're very different things. I think that's an important thing for people to be aware of. Yeah, we're not equating that. We're just sort of talking about how markets work. And we'll come back to the opening point there, that, listen, whether it's the stock market, whether what it's what we're talking about in terms of spreads between teams, whether it's going and buying avocados at the store, whatever it is, right, this is just how markets function. Hey, Jake, you mentioned the hundreds of billions of dollars that are transacted every day when it comes to buying stocks globally. Let me read you a couple numbers I had here when looking at legal sports betting, and this is for 2024, and I think that was the number you cited as well for 2024. All right, so I did a couple searches and here's what I found. In the U.S., and, again, this is legal sports betting in 2024, on an annual basis for the calendar year, $150 billion was wagered in 2024, which equates to $410 million a day. Now that's in the U.S., and you were just citing hundreds of billions of dollars every day transacted in buying and selling of stocks all around the world. So you just take a look at these buyers and sellers coming together, the volume at which that is happening, putting a fair price on this, all expectations about that particular company, the profits, I mean, just that's what markets do. They bring all that new information together. I mean, that's what it is, right? Everybody's got a view, everybody's got an opinion, but really think about that. I mean, that's a good example there. And those numbers are interesting to me. I think it's over $800 billion transacting world equity markets every single day. And just, I mean, think about the volume of that. The scale difference is staggering. The scale difference is staggering, right? And all it's equal. I mean, the more volume you have, the more informationally efficient prices are gonna be. I mean, if you didn't have even that level of volume with gambling, it would probably be a way less fair market, right? There'd be huge asymmetries in terms of information, but that's still pales in comparison to what we see from stock and bond markets, Trying to game the spread in legal sports betting. And then you take that over to the stock market, and trying to game the system and outguess the markets in the stock market, good luck. Really, really tough to do. And you see very little evidence in anybody be able to do that consistently. Hey, one thing, too, we talk about market prices is sometimes people say, well, let's talk about a stock. It's a great company. Like, it's gotta be doing well. Yeah, but going back to, again, how market set prices, the market knows it's a great company. It might be great leadership, maybe it's a great product, incredibly profitable. And so what does that mean? Well, if everyone knows it, there's a pretty high price reflecting the quality of that company. And usually that higher price usually indicates lower expected returns going forward. And the company could become even better. And then if you get a positive surprise that direction, the price can go even higher to reflect the new level of expectations. I mean, there's probably some of that happening with the Magnificent 7, right? Part of the reason why they've had such strong returns is because they've exceeded investors' expectations time and time again. But that also means those expectations get higher and higher to reflect the fact that people might think these are really good companies. I mean, that's the good team, right? You don't just get a bet on the good team, you gotta deal with the spread. That's exactly what we're talking about. You know, and this, everybody knows Ohio State is a good team this year, right? That's the reason that if you go and you look at the lines on a lot of the games, there's probably a pretty decent spread 'cause everybody knows it. I go back to, again, this idea of market prices. And for me, a take-away may be from somebody listening to the show today would be go back to, again, the sports betting, where, in so many cases, and you just alluded to that, was about 48, 49% on that study, depending on the sport. Like, it's a pretty fair representation on expected outcomes. And I just encourage the audience to take that mindset on publicly traded securities, that that's a pretty fair price reflecting all known information out there. And just sort of, I liked what you said earlier, Jake, about take that mindset of is there anything you know that's different that's built into those prices today? Probably not, assuming a fair game without insider knowledge, which we always joke, if you have that, and you trade on it. That's illegal. That's a risk-return story. That is a risk-return story. You maybe make money, but there's a risk of doing something illegal and jail time. That's right, yeah. No, I mean, I think that is, and it's hard, right? We talk about this a lot, like in a lot of aspects of life, the smarter you are, the harder you work, the all of those things, right? And you just, man, as an investor, you have to really push yourself to say, do I really think that I know something? And, again, we talked about the amount of volume, the amount of investors, the amount of people expressing their opinions, all the information that's out there in stock prices. Tough thing to say that you got more information than the rest of the market. Hey, Jake, you did an outstanding webcast with Professor Cochrane. Nice work on that. Well, he always has such great stuff to say. He's great. In the show notes, everybody, be sure to check that out in the show notes. There'll be a link to where you can watch that recording of that webcast Jake did with Professor Cochrane. So thanks for joining us today. Have a fantastic rest of the day.