Ian’s up this week with a discussion of P/E ratios and spendthrift baseball owners.
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As many of you probably know, I am a White Sox fan. Not only has this been an extremely painful experience (17 years since our only World Series), but it also nearly cost me a first date, so yeah - you could say I’m a little annoyed with my chosen baseball team. Luckily, I also root for the Bears, Bulls, and Illini teams, so I am very accustomed to disappointment.
*Editor's Note: This was written before the White Sox signed Benintendi to a 5yr/$75 million deal, the Sox are so back*
Right now, baseball is in the midst of free agency, where teams spend ludicrous sums of money on players for the next decade of their service.
Exhibit A:
That is a LOT of money, and it’s all guaranteed. So, here’s your financial advice for the week: be a professional athlete - it pays very well, and it’s pretty awesome.
Just kidding, we have much more boring things to cover like earnings multiples!
But first, back to the real point of this blog which is how much I hate the White Sox their owner Jerry Reinsdorf (he also owns the Bulls, who stink btw) for failing to spend money; while everyone else is out spending money on generational talent like Aaron Judge or Carlos Rodon who received $162 million from the Yankees, the White Sox haven’t spent diddly. And if you wonder why I included Rodon and not some other high-profile free agents in this story…
Yeah, the White Sox had that guy and didn’t want to pay him even a fraction of what the Yankees just did.
Some of you might be saying well, that’s a lot of money. These guys get paid to play a game. Why are players being so greedy?
And to that I say.
Owners of professional sports teams have seen valuations skyrocket over the last 20 years. Even baseball, which is often seen as a declining sport, has seen drastic increases in value.
That’s a jump from $286 million to $2 billion for the average team over the last 20 years! Please feel free to quote the Rock the next time an owner is crying poor.
Now when they are crying poor, they are often referring to their operating income or loss for any given year rather than quoting the overall value of their franchise. That’s fair, to an extent, since how much you make in a given year is certainly important. You probably wouldn’t be that excited if your investment portfolio was up in the same year you lost your job and had to drain your savings to pay rent.
The problem is owners of these teams are often crying poor for the wrong reasons. I mean sure on “paper” they may have lost a lot of money, but on “paper” I also spent lots of money “entertaining clients” on my boat this summer, y’know, for tax reasons and such.
Something clearly possesses more value than simply a vehicle for tax write-offs if it’s worth $2 billion, even for a vanity project like owning a baseball team. Billionaires are a competitive bunch, and they didn’t get rich losing money.
Let’s look use the stock market as a benchmark for what a company “should be” worth using something called Price to Earnings ratio or P/E. P/E tells you how much you need to pay for every dollar of earnings the company generates. So, if a stock has a P/E ratio of 10x, you’d have to pay $10 for every $1 of earnings.
Different companies get assigned larger P/E ratios depending on a lot of factors, with a lot of it focused on the growth of the company which we covered a while back. But In aggregate, the 505 stocks tracked by the S&P 500 Index feature an average P/E ratio of about 20x. Meaning, the average US stock is “worth” 20x what they make in a given year.
Now let's apply this to baseball teams. Owners have claimed that they are making peanuts, in one report before the pandemic it was claimed that across 30 MLB teams they made a total of $42 million a year. Or roughly $1.4 million a year.
In that same article, Forbes estimated they made roughly $1.5 billion in 2020 alone which equates to $50 million per team. If we apply the P/E Ratio from above, you get a pretty BIG difference in the numbers:
So either this group of 30 billionaires has completely overpaid for a business that is failing by a massive factor (actually Elon kinda did this with Twitter)
OR
They are lying about their income in an effort to avoid paying taxes and even worse, paying for my favorite players.
What’s the Upside?
Valuing companies is often tricky, but at the end of the day, follow the money. Baseball owners may be vain gloryhounds with a deluded sense of their own worth, but they aren’t stupid.
FWIW, I was coming up short on what to write about after a week of holiday parties, so I jammed in something boring like P/E ratios with a rant about the White Sox. Enjoy.
