MAKING SENSE OF AUCTION PRICES AND BUY-BACK RATES

Making sense of recent bloodstock auction sales prices is tricky.  Whether depressed prices and a high percentage of buy-backs are mostly attributable to overall conditions in the broader global economy or are mainly the result of something specific to horse racing is the unknown.  Teachings of the late Benjamin Graham, the father of value investing and security analysis, offer perspective.

Graham was a professor at Columbia Business School and a mentor to his student Warren Buffett, as well as to other future investing greats.  Graham famously taught that the stock market in the short term behaves like a voting machine, whereas in the longer term (seven to ten years), it behaves like a weighing machine.  Over a relatively brief period of time, investors can expect erratic variations in stock prices affected by day-to-day events, emotion, and crowd psychology; but over a longer period of time the correct values will emerge, based on underlying economic fundamentals.  For example, in the late 1990s, investors en masse emotionally voted for dot-com technology stocks, regardless of the lack of sound economic rationale for doing so, and this mob speculation drove the Nasdaq exchange up to record levels.  By March 2000, the market had had time to weigh the evidence and the bubble in dot-com stocks began to burst.

In the 1980s, bloodstock markets soared, then declined, and since have ebbed and flowed.  Presently, auction prices are stagnant, buy-backs are elevated, and the future is uncertain and unknowable.  In the short term, the offspring of a few hot new stallions or the infusion of several deep-pocketed owners may boost prices.  Or a contagion of pessimism may depress prices.  However, in the longer term, the market will weigh the economic underpinnings of horse racing and bloodstock prices will respond accordingly. 

The main economic fundamental is purse levels, as in turn derived from pari-mutuel wagering and, in some cases, slot revenues.  If proceeds from these sources fall, bloodstock prices over the longer term will inevitably follow suit.  Conversely, bloodstock prices would benefit from upturns.

Graham counseled investors to welcome depressed markets because it enabled them to buy undervalued stocks and hold them until such time that they become appropriately valued.  Moreover, an investor should not let the day-to-day volatility of “Mr. Market” shape his or her decisions, which can lead to poor outcomes.  Rather, the investor should estimate a business’s true value—its intrinsic value–over the longer term, as dictated by a rational examination of the facts.  As shrewd bloodstock buyers know, auction markets on the downswing offer the best opportunities for bargains.

Horse racing is not a pure business in that prices are not established solely by economic fundamentals.  Sport plays an important role.  Two competitive buyers at an auction can set their sights on the same colt or filly and bid up the price far beyond what the risk vs. reward calculation would indicate is justified.  But over a plethora of auction sales and over seven-to-ten years’ time, the bloodstock market will weigh the underlying economic fundamentals–as measured by trends in purses, pari-mutuel handle, and slots revenues—and the supply of horses and the prices buyers are prepared to pay will adapt. 

Copyright © 2011 Horse Racing Business

Originally published in the Blood-Horse.  Used with permission.

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