Investing Lessons From Formula 1 | The Acquirer's Multiple®

In their latest episode of the VALUE: After Hours Podcast, Brewster, Taylor, and Carlisle discuss Investing Lessons From Formula 1. Here’s an excerpt from the episode:

Jake: [laughs] Yeah, that’s not as much as it seems. All right. We’re going to be talking about the 1998 Hungarian Grand Prix F1 race. So, feel free to chime in with your F1 knowledge, Billy, because you know more about it than I do. In this race, Michael Schumacher, who’s one of the all-time great drivers, is racing for the Ferrari team and may have been equipped with gear like that snell sa2020 helmet. And the two McLaren cars for their team were faster in their qualifying times and had better starting positions. So, that’s the setup for this race. Now, as you guys know, raw speed isn’t always the deciding factor in winning races. There’s actually a fair amount of decision making that happens that’s also key. Like, how do you plan for the race? What’s your approach to pitting? That’s what we’re going to be talking about here. All the other teams for this particular race chose a two-pit-stop strategy. That was their plan. How much fuel, tires, all that stuff that gets–? They change it in 10 seconds. So, Ferrari decided to be nonconformist and they did a three-pit-stop strategy. So, here we have these competing strategies.

So, you’re probably fairly wondering, you’re sitting in the pits, the clock is running, everyone’s out there and going 200 miles an hour while you’re stopped. How are you going to win if you’re obviously way slowed down by sitting in the pits for a third time when everyone else is only doing two times. So, if you’re Ferrari and you’re starting with a weaker starting position, and you’re choosing to be in the pits more, doesn’t that seem like a stupid strategy?

Here’s what the difference was. First of all, amount of fuel. So, fuel is heavy, relatively speaking. And at this track, each additional 22 pounds of fuel cost a car about a third of a second per lap. If you imagine using three stops, Ferrari was able to run with around 66 less pounds of fuel through most of the race, which enabled them to go faster by 1.1 seconds per lap. So, I would say the takeaway for the investment side for this particular part of it is that obviously, having a smaller asset size is a bit of an advantage because you’re more nimble, you can go places that other people can’t go, you’re not burdened by size as much.

Number two, by doing three instead of two, Ferrari was basically out of phase with their competitors. Everyone else is all stopping at the same time roughly, but they’re doing three instead of two, that gives them more free time out on the track when it’s relatively open. So, there’s less jockeying for position. They’re able to run more qualifying laps, which is you’re out there racing almost by yourself so you can go faster, you’re not trying to get around people who are going slower. The takeaway from that would be that– maybe I’d be curious to hear, Toby, what’s your quant testing about this says, but it might be better to lag some of your rebalancing in a quant strategy to be out of phase with what everyone else is doing.

Tobias: You would be [crosstalk] face the SPY. That’s what you’re going to try to do.

Jake: Is that the key?

Tobias: [crosstalk] spy rebalances, everybody rebalances around SPY.

Jake: Okay. Did you find that that was like advantageous? If you did stay out of phase with everyone else?

Tobias: It was more an operational thing, just that it was hard to do it on those days. You’re better off doing it on other days. I’m not entirely sure that there’s a performance advantage to doing that. Just that it’s easy on the ops team.

Jake: Okay.

Tobias: It’s probably a good thing.

Jake: Speaking more qualitatively, if that’s more your game, I personally try to wait at least a week before I go look at a new 10Q that’s come out. I just want to let the noise die down first. Let everyone else pit stop together on it, and fight, and try to figure out what it’s worth and be influenced by Mr. Market. But I’m going tried to be out of phase with them, let it die down, and process the information. Hopefully, have a little bit more of a qualifying lap for myself to not have to dig through as much.

Tobias: Do you worry that you get secondhand reports of what’s in there before you get your own look at it?

Jake: Yeah, that’s why I try not to read anything about it.

Tobias: Yeah, fair enough.

Jake: I don’t want anyone else’s voices in my head. Then the third thing that happened was tire choice. Ferrari was able to make different tire choices as the track conditions changed. Everyone else only got to make two decisions as opposed to a Ferrari got to make three decisions. So, the takeaway there is that even though it can feel it’s taking more time than necessary to have these extra pit stops, it’s useful I think to be able to evaluate the track conditions that you’re in more regularly than maybe some people, which might look like re-underwriting a lot of your positions as it feels track conditions are changing and really asking yourself like, “Do I need to make changes in the portfolio based on what the conditions look like? Do you have the right tires for the next section of the track?”

Buffett is largely celebrated for having these long holding periods. He wants to hold forever. But I think it’s instructive to remember how quickly he punched out of airlines when he felt the track conditions changed. I feel it’s a little bit underrated how he’s willing to pit stop maybe more than others give him credit for. So, in the end, Ferrari ended up winning the race by choosing what apparently looked like a slower and more laborious process by having three pit stops instead of two and yet, it allowed them to make adjustments in the race that other teams couldn’t, so I think there’s just something to be said about our process, and really thinking through it, and having more check-ins maybe regularly on your investment process, and not letting it go too far and drift from what track conditions are changing.

Tobias: Let me ask you a question. So, you pit three times instead of two. You’ve got 10 seconds of additional time that you have to make up somewhere. And you said you carry 66 pounds less fuel, which means that each lap on average is 1.2 seconds faster. So, you got- [crosstalk]

Bill: All else equal.

Tobias: -eight laps.

Jake: Yeah. Right.

Tobias: All else equal. So, you get eight laps-

Bill: You get new tires.

Tobias: -to catch up. New tires. Okay.

Bill: It’s going to make you quicker.

Tobias: Eight laps to catch up. So, how many laps are those races? How many laps is that race?

Jake: I don’t know how many laps that races. I don’t know. BB, you probably have a better sense of– [crosstalk] these.

Bill: I don’t know. That one, no.

Tobias: More than 24?

Bill: Let’s assume Ferrari calculated it.

Jake: I think there are a lot.

Bill: There were sufficient laps.

Jake: I think they are like in the–

Bill: Yeah, there are more than 24, for sure.

Jake: [crosstalk] 50 or I don’t know. 100?

Bill: Yeah, it was 86, I think. Somewhere around that.

Tobias: It was a quantitative decision. It was a mathematical decision that even with one extra pit stop, that would make them– provided they made some adjustments– as long as you don’t run with a full fuel tank, you run a little bit lighter, because you pit more often.

Jake: Right.

Tobias: It is interesting, but then you’ve got some risk. Because every time you pit, there’s a risk that the pit stop– [crosstalk]

Bill: Yeah, if [crosstalk] goes wrong.

Jake: Yeah, that’s true. Just like you can’t get the tire off or something bad happens.

Bill: You zig them with the zag.

Tobias: That’s a good strategy.

Jake: Yeah, you are trying to zig a little bit.

Bill: Zig.

Tobias: Is that no longer the case that the–? [crosstalk]

Bill: Can we say zig or we allowed to even say the word–? [crosstalk]

Tobias: Without context, it’s okay.

Bill: Okay, that’s good. Yeah.

Jake: [laughs]

Bill: It’s like Voldemort.

Tobias: [crosstalk] whatever SEC regulators [crosstalk] in the future.

Jake: You can’t say bomb on a plane.

Tobias: [laughs] Yeah, that interesting, JT. It presumably makes you a little bit more robust, although they were running with less fuel. So, they were running about up to the red line as much as anybody else was.

Jake: But I was thinking about this too, I think there’s something to be said about running with a little less fuel psychologically, like less stuff weighing you down, that extra stress outside that might be coming in and impacting your decision making. I think running lightweight up here mentally is actually a pretty big advantage.

Tobias: It’s one of the reasons I like smaller position sizes, because you don’t have to put so much– Once you get into an 8% plus position size, you really got to be-

Jake: That’d be right.

Tobias: -pretty certain about what you’re doing. I just can’t get to that level of certainty, which is why– 3.5% could be pretty Zen. I would consider like Facebook at 3.5% is a no-brainer. Bigger than that aside getting now, we’re going to really know what’s going to happen and I don’t think you can, I wouldn’t be comfortable doing more than 3% for anything other than Berkshire, like those kinds of enterprises where you’re just certain.

Bill: I don’t know how certain you can be with Berkshire. I understand why you say it and I’m not trying to talk down about Berkshire.

Tobias: Well, I’m interested. What’s the concern?

Bill: Well, you got two of the guys– [crosstalk] Well, two of the guys are going to be gone.

Tobias: That’s fair.

Bill: I don’t know what it’s going to look like in 20 years. That thing can unravel a lot quicker than I think a lot of people want to admit, myself included.

Jake: Might want to have a pit stop before that 20-year marker. Just checking.

Tobias: Yeah, that’s a fair point.

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