5 Investing Lessons from NFL Free Agency

By Markets Fool.com

The New England Patriots are Super Bowl champions. There is a reason, despite the parity generated from a hard salary cap; the Patriots have appeared in 6 Super Bowls and 9 AFC championships over the last 14 years. While many place that success on the right arm of Tom Brady in January, the foundation of the Pats' dominance is annually laid by Bill Belichick and the Patriots front officein March. The disciplined strategy used by consistently successful franchises in free agency has direct parallels to winning strategies used by top stock pickers. Investors would do well to adopt these 5 lessons learned from building rosters in the modern era of the National Football League.

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Self-evaluate accurately
Consider your stock portfolio like an NFL roster. Even good NFL teams struggle when evaluating the level of talent on their own rosters and volumes have been written on how different biases distort investors perception of their own portfolio. It is easy to confuse hope for a plan when you have an emotional attachment to a pick. For instance, the second worst team in football, the Tennessee Titans, are currently acting like Zach Mettenberger is a starting caliber quarterback. This is like banking your retirement on a penny stock turning into a blue chip. It could work out, but the odds are wildly against you. Fact: No quarterback drafted from rounds 4 -7 since Tom Brady in 2000 has become a reliable starter. Biotech investors are notorious for ignoring red flags like questionable trial results and safety data only to be shocked when an FDA rejection wipes out half of their investment.

Acknowledge opportunity cost
Like a salary cap, most investors have limited dollars at their disposal.The business side of the National Football League can be cold-hearted. Approach your portfolio with the same, "what have you done for me lately?" attitude of an NFL general manager. It is great if you are sitting on multi-bagger gains, but has that investment matured to the point your thesis no longer rings true? If you didn't own that stock currently would you buy it today? Without that conviction it is time to move on, because there is an opportunity cost to inaction. Peyton Manning, the greatest regular season quarterback of all time, got cut as soon as a better opportunity presented itself in Andrew Luck. Luck is currently the single most valuable asset in the league and the Colts didn't lose out because a hall of famer was already on their roster. This also keeps general managers and investors alike from getting burned on the inevitable downside that comes when age or competitive forces cause decline.

Don't chase the hot names
It is why a team like the Miami Dolphins routinely "wins" free agency and yet sits out of the playoffs. Year after year a big free agency prize ends up a big free agency bust. Just because a player was performing at a high level doesn't mean they will continue to do so; past performance is no guarantee of future results. Especially in the case of one-year wonders, where a lack of consistent success raises the risk level. Investors are better off going against the crowd, hunting for the ignored, the passed over, the diamonds in the rough. The Seattle Seahawks used this strategy when signing pass rushers like an injured Michael Bennett to cheap, short deals in route to their first Super Bowl title. Any player or investment in this category carries a couple blemishes, but if everything were perfect, it wouldn't be available at a discount. Nothing brings this home more than the following stat: in 2013, Wall Street's top 10 most recommended stocks returned on average 22% while the 10 stocks with the greatest number of sell ratings returned 75% on average.

Don't pay a premium for mediocrity
This is basic common sense, but it needs to be said, because it is a common pitfall. When a team needs to fill a gaping hole on their roster they will often pay top dollar for a midlevel talent and project a previously unseen degree of performance onto the player. These deals generally disappoint and drain available resources. It is better to wait out the buying frenzy.Investors need to be careful when filling needs in their own portfolio, especially when they have the luxury of time on their side. When a megatrend hits the mainstream, investors clamor to get exposure often regardless of timing, quality, or price. It is however, worth riding already successful ideas. The Packers biggest free agency moves are locking up their own star players before they hit the market. If the due diligence is already done and the investment thesis is still playing out, don't be afraid to add to a winner. This stock is a known quantity, reducing the risk of a negative surprise.

Strike when opportunity arises
When an opportunity falls in your lap, don't hesitate. When the Denver Broncos couldn't figure out how to successfully operate a fax machine, the Baltimore Ravens scooped up talented edge rusher Elvis Dumervil, who had 17 sacks in 2014. When a perpetually bad situation in Oakland made Randy Moss look finished and the Raiders dying to wash their hands of him, New England gave Moss a shot and he responded with 23 touchdowns as the Pats went 16-0 in 2007. Always be on the lookout for a market overreaction to a high quality company.Netflixis a fantastic example. Back in 2011, the company shockingly announced it was dramatically raising prices, severing its combined $9.99 single DVD and unlimited streaming plan into two separate $7.99 per month services. Subscribers were irate with the price hike and what had been robust subscriber growth became a net decline, slicing shares in half from $300 down to $150. Add on top of that the loss of Starz content and chaos around the failed rebranding of its legacy mail order DVD operations as Qwikster that inspired aSaturday Night Live spoof, sawshares continue to free fall down to $65. However, despite the headlines, Netflix's subscriber losses were not that significant and soon rebounded, the company continued to sign content deals, paving the way for doubling the domestic user base and sending share prices soaring to $445. The lesson is the market makes short term mistakes all the time, do your homework by looking beyond the headlines at the underlying health of the business and be prepared to capitalize when the opportunity presents itself.

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And speaking of opportunities falling right in your lap...

The article 5 Investing Lessons from NFL Free Agency originally appeared on Fool.com.

David Williamson has no position in any stocks mentioned. He has nailed preseason predictions for the participants and winners of the last 2 Super Bowls. The Motley Fool recommends Netflix. The Motley Fool owns shares of Netflix. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.