Finding Opportunities Using The NCAA Pairwise Rankings

During their latest episode of the VALUE: After Hours Podcast, Huber, Taylor, and Carlisle discuss Finding Opportunities Using The NCAA Pairwise Rankings. Here’s an excerpt from the episode:

Huber: So, I was just curious to see– what I really wanted to do with this little mini-project was figure out how the management teams allocated capital. So, in 2020, 2021, banks got huge amounts of deposits from the fiscal stimulus and the monetary stimulus that took place. It’s very interesting to look at the cash flow statements, which is a forgotten aspect of bank financial statements. But the cash flow statement you can use to see, “Okay, where did the money come in? How much did they get in deposits? And then where did it go? Did they put it into loans? Did they put it into bonds at 50 times earnings?” which is what a 2% yield is. Is that’s what Silicon Valley Bank did.

Jake: Oops.

John: Did they hold their fire? Did they keep it in cash or in T bills, which right now looks like a great decision, but at the time, at 0% interest rates, that was maybe a difficult decision to make. So, it’s just interesting to see how these management teams allocated capital. So, I’m going through this list and I’m thinking there’s just too many– You get analysis paralysis. I’m sure you guys have probably experienced that from time to time. I don’t do a lot of screening, but I do look at a lot of A-to-Z lists, whether it’s industry groups or just random lists that I’ve uncovered from time to time. I used to go through Value Line and I have a whole list of the Value Line stocks. I’ve always had these little systems to, almost like a hack, try to like, “How do I filter these?”

So, coincidentally, I was talking to a client of mine a few weeks ago, and we were talking about the Frozen Four, the way that the Frozen Four, which is the collegiate hockey tournament, how they rank their teams. And so, everybody knows about the Final Four. The lesser-known cousin is the Frozen Four, which is NCAA hockey’s version of bracket. There’s 16 teams instead of 64, but it’s very similar. It’s a single elimination tournament. So, picture 16 teams in a bracket. But what’s interesting about it is there’s a system that the NCAA uses to rank all 61 NCAA Division 1 hockey teams, and it’s called the pairwise system.

And the pairwise system is a very simple comparison tool that uses three categories, and you get one point for each category. The three categories are head-to-head, common opponents, and RPI. Head-to-head is self-explanatory. That’s like Michigan versus Minnesota. So, if Michigan and Minnesota are being compared in this pairwise comparison, let’s say Minnesota beat Michigan. Okay, Minnesota gets one point. The second is common opponents. So, how did Michigan and Minnesota do against– Let’s say they both played Ohio State and Boston College. And let’s say Minnesota won both and Michigan won one and lost one. So, Minnesota had a better record against common opponents, so they would get a point. Now, it’s 1-1.

The third point is RPI. And the RPI is a little bit more complicated, but it’s a rating and it’s based on winning percentage and strength of schedule. Let’s say Michigan has a higher rated RPI. So, they would win that pairwise comparison 2-1. And so, what’s interesting about the system is you can rank all 16 teams. The system is used to select– It’s a little complicated but once you have the 16 teams selected, the system ranks 1 through 16.

I was thinking like, “This would be an interesting way to–” After talking to my client and I’ll give him credit for this idea, I started thinking like, “Maybe there’s a way, just for fun, to use some your own internal checklist to rank stocks.” I was in the midst of this little research project I was doing and I was thinking, “Okay, I need something like this to filter– If I have a hundred stocks that look interesting– My style of research, I like to do deep dives, so I want to try to meet with the management team if I can. I want to make phone calls and really do some research. You have to have some way to prioritize what you’re going to work on.

So initially, I thought, “Well, I could adapt this system to my own four-point checklist.” So, you could have a three-point checklist. You could have business quality, management quality, and value. So, I was thinking you could rank stocks in your portfolio using a three-point pairwise comparison, and you could compare any stock in your portfolio. If you have O’Reilly and, let’s say, Fastenal, you could compare those two against each other and see which one’s better, which one should get the higher weighting.

Again, this is just for fun. This is not to automate decision making. It’s more just to aid decision making. It’s really just a tool to– like a check and balance, it’s like food for thought. I started using it just for fun to use my own four-point checklist that I just described to you, guys. It’s durability, its growth potential, its capital allocation, and value. Since I have four, you could have a 2-2 tie. So, I use valuation as the tiebreaker.

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