Value for Money
The most difficult investment problem in the world.
In his early days as a professional investor, Warren Buffett focused on “cigar butt” stocks.
“If you buy a stock at a sufficiently low price, there will usually be some hiccup in the fortunes of the business that gives you a chance to unload at a decent profit, even though the long-term performance of the business may be terrible. I call this the ‘cigar butt’ approach to investing. A cigar butt found on the street that has only one puff left in it may not offer much of a smoke, but the ‘bargain purchase’ will make that puff all profit.”
Berkshire Hathaway – the textile manufacturer, not the holding company it became – was bought as a cigar butt. Buffett was then a straight-ahead Benjamin Graham disciple. Graham, the father of value investing, had started using the cigar butt approach during the great depression.
This investment style became increasingly difficult. As Buffett’s holdings expanded, there were no longer enough cigar butts lying around to feed the beast. Moreover, if turnover isn’t quick, the poor performance of the company erodes the advantage. “Time is the friend of the wonderful business, the enemy of the mediocre.” Finally, the alleged bargain may be less attractive than expected. “[N]ever is there just one cockroach in the kitchen.”
Buffett, largely due to Charlie Munger’s influence in this case, adapted and adjusted: “It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” In related news: “Good jockeys will do well on good horses, but not on broken-down nags.”
These investment lessons – getting value for money – are the subject of this week’s TBL.
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Value for Money
For my money, the most interesting investment problem of our time is not the dispute about active versus passive investing, the nature and extent of the equity risk premium, the importance of international diversification, the relative value of growth and value stocks, or whether Tesla should be bought or shorted.
The most interesting investment problem today is how to build an NFL roster to win a Super Bowl with a hard salary cap.
And there is no way for an NFL general manager to get market returns.
Since 1994, The National Football League has operated with a salary cap – a maximum amount teams may spend on player salaries and bonuses – based upon revenues, with a negotiated percentage of those revenues (per the collective bargaining agreement between the league and its players) designated for player salaries. That first year, the cap was $36.4 million per team. In 2024, it will be $255.4 million, an increase of about $30 million per team over 2023. The salary cap is designed to keep costs predictable and limited, to prevent excessive risk-taking by individual franchises, and to maintain competitive balance among the teams by restricting richer clubs from outspending their rivals on players.
In short, it’s about parity and cost-control. And it works.
Over the last seven seasons, all but two NFL teams have made the postseason at least once (the Denver Broncos and New York Jets are the exceptions). No other American professional sports league can boast such parity.1 Meanwhile, player costs – the biggest budgetary line item for teams – are known and fixed.
Obviously, the effective management of player compensation directly results in an increase in wins (see here, pp. 131ff.). Therefore, roster construction is about more than finding, scouting, and signing the best players. It’s about finding the right players for the right price – finding value for money.
A so-so player who comes cheap isn’t going to help except, perhaps, to fill out a roster. A great player who costs too much is going to limit other options, perhaps fatally.
Nowhere is this more evident than with quarterbacks.
Steve Young signed a $25.25 million contract extension with the San Francisco 49ers one year before the NFL instituted the salary cap. That first capped season was capped off with Young leading the 49ers to a Super Bowl championship in early 1995. He threw for 325 yards and six touchdowns in the big game and was named its MVP. His salary cap charge was 13.1 percent of the total cap.
Until Patrick Mahomes the last two years (17.5% in 2024, 17.2% in 2023), no Super Bowl winning QB had a higher cap hit percentage than Steve Young.2 Indeed, before Mahomes, only five quarterbacks since Young have won a Super Bowl while taking up even 10 percent of their team’s salary cap: Brett Favre in 1997 with the Packers; Peyton Manning in 2007 with the Colts and 2016 with the Broncos; Eli Manning in 2012 with the Giants; Tom Brady in 2015 and 2019 with the Patriots and in 2021 with the Buccaneers; and Matthew Stafford 2022 with the Rams.3
During the period between Young and post-rookie contract Mahomes, there was a widespread belief that Young’s 13.1 percent cap hit was a ceiling – that no team with a cap hit in excess of 13.1 percent would win a Super Bowl (call it “the Young threshold”).
Balancing the need for great quarterback play with the realities and limitations of the NFL salary cap is a fascinating problem.
Of the 30 teams that won Super Bowls in the salary cap era, the quarterback was the highest-paid player half the time. Over three in four were among the top three. The exceptions were mostly outstanding QBs on “rookie contracts,” the values of which were held down by the NFL’s collective bargaining agreement.
For example, Russell Wilson took up 0.6 percent of the Seahawks’ salary cap when Seattle routed Peyton Manning (12.5 percent) and the Denver Broncos in the 2014 Super Bowl.
There are few examples of mediocre quarterbacks winning Super Bowl titles.
NFL quarterbacks are the most important players in any sport (rules changes in 2013 to benefit the passing game accelerated an existing trend).4 In today’s NFL, it is possible to win a Super Bowl without a great (“franchise”) quarterback, but it’s rare enough that no team should want to try. The last 11 NFL MVPs have all been QBs (16 of the last 17; and 21 of 24 since 2000). That goes a long way toward explaining why two-thirds of first overall picks in the salary cap era (30 years) have been QBs. In this year’s NFL draft, quarterbacks were chosen with each of the first three picks and with six of the first twelve.
Great quarterbacks cost a lot of money. From 2018 to 2023, the NFL’s highest-paid quarterback saw his pay increase a total of 64 percent, while the NFL’s salary cap increased just 26.5 percent. However, only about half of first round QBs “make it” in a meaningful way, much less win a Super Bowl. And lots of QBs, even outstanding ones, are overpaid.
Accordingly, if too much of a team’s salary cap is tied up in its quarterback or the QB doesn’t provide sufficient value for money (if those things are different), the team won’t have enough capital left to provide the weapons needed to win a Super Bowl. An expensive QB makes it exceedingly difficult to have depth on the offensive line, to pick up a good third receiver, to improve the pass rush, or to add secondary depth.
Before Mahomes, plenty of terrific QBs had not won Super Bowls when paid over the Young threshold. Examples include Peyton Manning (six times), Drew Brees (four times), Eli Manning (three times), Aaron Rodgers (three times), Ben Roethlisberger (three times), Troy Aikman in 1997, Brett Favre in 2001, and Tom Brady in 2006.
The Atlanta Falcons made the Super Bowl in 2016 with Matt Ryan at quarterback despite a cap hit of 15.4 percent.5 In 2009, Indianapolis got to the Super Bowl despite paying Peyton Manning a staggering 17.2 percent of the cap. But they didn’t win.
The last six Super Bowls all featured quarterbacks on cheap rookie deals. But those rookie-deal quarterbacks went 1-5, with only Mahomes winning it all at that stage.
Tom Brady’s cap hit averaged 7.8 percent during his seven Super Bowl winning seasons. He only exceeded the Young threshold once, and didn’t win the championship that year. Peyton Manning, on the other hand, exceeded the Young threshold six times and didn’t win the Super Bowl in any of those years. The two seasons he won it all? He was below the Young threshold.6
Even so, only one quarterback per year wins a Super Bowl, so it’s easy to overstate what the data means. In other words, small sample size.
There are ways for teams to juggle their cap numbers, of course. Most obviously, cheap rookies help. Players on rookie contracts provide about half of the overall performance value provided in the NFL. By my rough count, 64 of the 92 players who appeared on the Chiefs’ roster this past season were on rookie contracts. In the 2023 Super Bowl, the Chiefs’ 47-man gameday roster included 10 rookies (and their cheap contracts). Just one other NFL champion from the salary-cap era (the 2008 New York Giants) had a higher percentage of rookies on its Super Bowl roster. The Chiefs had six more rookies on its gameday roster for the most recent Super Bowl.
Flirting with the Young threshold – or even exceeding it – and winning the Super Bowl isn’t impossible if the QB is an all-time great like Mahomes. But anything less makes winning difficult.
To emphasize the obvious: Teams whose QBs make a ton of money (irrespective of the Young threshold) have a difficult road ahead without truly exceptional play from the guy behind center.7
Therefore, were I a fan of the Browns (Deshaun Watson, 25.0%), the Cowboys (Dak Prescott, 21.7%), the Rams (Matthew Stafford, 19.4%), the Cardinals (Kyler Murray, 19.2%), or the Giants (Daniel Jones, 18.8%), I wouldn’t be too optimistic for the upcoming season.
Totally Worth It
I write this edition of TBL on the 80th anniversary of D-Day. That day in western France was the pivotal day and the pivotal event of the 20th Century. As Omar Bradley pointed out, every man who set foot on the beaches of Normandy on June 6, 1944 was a hero – the men who took the cliffs to fight tyranny and took back a continent for freedom. I dare you to try to watch footage of and about that horrible, dreadful, wonderful day with dry eyes or a cold heart.
Here’s to the boys of Pointe du Hoc. In the words of Stephen Spender, these are men who in their “lives fought for life and left the vivid air signed with [their] honor.”
For what they did at D-Day and beyond, we describe that group as the “greatest generation” – who had, in FDR’s phrase, a “rendezvous with destiny.” They were largely born in a time of promise and prosperity shortly after what was supposed to be “the war to end all wars.” But, instead, they saw many of their dreams dashed by depression and yet another world war.
Still, they persevered.
The greatest generation offered us their legacy of liberty and so very much more. When they “left the field” to us, America had become the world’s sole superpower, with an economy that was the greatest the world had ever known and filled with opportunity for those with the industry and ingenuity to make the most of it, a tremendous educational system, a vibrant middle class, state-of-the-art infrastructure, and a functional and representative government.
Only a few are left. Here’s to them and to the memory of their comrades.
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Benediction
We live on “a hurtling planet,” the poet Rod Jellema informed us, “swung from a thread of light and saved by nothing but grace.” To those of us prone to wander, to those who are broken, to those who flee and fight in fear – which is every last lost one of us – there is a faith that offers grace and hope. And may love have the last word. Now and forever. Amen.
As always, thanks for reading.
Issue 177 (June 7, 2024)
The NFL’s unbalanced schedule, that pits the top teams from the previous year against other top teams, is also a factor.
Here is the list of Super Bowl winning QBs during the salary cap era, from the highest cap hit to the lowest: Patrick Mahomes (2024): 17.5%; Patrick Mahomes (2023): 17.2%; Steve Young (1995): 13.1%; Tom Brady (2021): 12.6%; Tom Brady (2018): 12.4%; Peyton Manning (2016): 12.2%; Eli Manning (2012): 11.7%; Tom Brady (2015): 11.1%; Matthew Stafford (2022): 11.0%; Peyton Manning (2007):10.4%; Brett Favre (1997): 10.2%; Brad Johnson (2003): 9.6%; Eli Manning (2008): 9.2%; Tom Brady (2017): 8.9%; Drew Brees (2010): 8.7%; Ben Roethlisberger (2009): 6.9%; Troy Aikman (1996): 6.7%; Joe Flacco (2013): 6.6%; Tom Brady (2005): 6.3%; Aaron Rodgers (2011): 5.4%; John Elway (1998): 5.2%; John Elway (1999): 5.0%; Ben Roethlisberger (2006): 4.9%; Tom Brady (2004): 4.4%; Patrick Mahomes (2020): 2.4%; Trent Dilfer (2001): 1.6%; Kurt Warner (2000): 1.3%; Nick Foles (2018): 1.0%; Russell Wilson (2014): 0.6%; and Tom Brady (2002): 0.5%.
The Patriots were paying Drew Bledsoe 12.3 percent of the cap in 2001 when they won the Super Bowl, but he got hurt in the second game of the season and a young Tom Brady (0.47 percent of the cap) came in and started the rest of the season and playoffs.
A Harvard Business Review analysis determined that four leadership variables – quarterback, coach, general manager, and owner – explain more than two-thirds of the variance in NFL team performance, with the quarterback, at over 37 percent, clearly the most important of the four. QB is “the most critical factor in team success.” Accordingly, quarterback is by far the most highly compensated position in the game.
In 2015, the Carolina Panthers made the Super Bowl while paying Charles Johnson, a defensive lineman, 13.78 percent of the cap.
More recently, and in general, most Super Bowl winning teams without QBs on rookie contracts have paid their signal-callers 10 percent or more.
Here are the salary cap hit figures for the 25 most expensive NFL QBs this coming season: Deshaun Watson (Browns): 25.0%; ; Dak Prescott (Cowboys): 21.7%; Matthew Stafford (Rams): 19.4%; Kyler Murray (Cardinals): 19.2%; Daniel Jones (Giants): 18.8%; Patrick Mahomes (Chiefs): 14.5%; Lamar Jackson (Ravens): 12.7%; Josh Allen (Bills): 11.9%; Joe Burrow (Bengals): 11.6%; Jared Goff (Lions): 10.6%; Geno Smith (Seahawks): 10.3%; Kirk Cousins (Falcons): 9.8%; Tua Tagovailoa (Dolphins): 9.1%; Justin Herbert (%#@*&^): 7.6%; Aaron Rodgers (Jets): 6.7%; Jalen Hurts (Eagles): 5.3%; Jordan Love (Packers): 5.0%; Derek Carr (Saints): 5.0%; Trevor Lawrence (Jaguars): 4.6%; Bryce Young (Panthers): 3.4%; C.J. Stroud (Texans): 3.2%; Gardner Minshew (Raiders): 3.1%; Jacoby Brissett (Patriots): 3.1%; Anthony Richardson (Colts): 3.0%; and Jarrett Stidham (Broncos): 2.7%.