“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return.” – Benjamin Graham, The Intelligent Investor
“I believe that the greatest long-range investment profits are never obtained by investing in marginal companies.” – Philip Fischer, Common Stocks and Uncommon Profits
Benjamin Graham, often considered the founder of “value investing,” published the most influential book in investing, Security Analysis, in 1934. The book was, in many ways, written in response to the rampant stock market speculation that led to the great Wall Street Crash of 1929 and comprehensive in laying out the intellectual foundation of value investing, which involves buying assets that appear underpriced based on some form of fundamental analysis. Mr. Graham would go on to be the mentor to famed investor Warren Buffet, as well as publish The Intelligent Investor, a more focused version of Graham’s value investment philosophies, which became one of the greatest selling books on investing.
Philip Fisher, on the other hand, was notable for being one of the founding architects of “growth investing,” a style of investing that is less focused on buying undervalued assets and more so on those that can generate long-term capital appreciation. His landmark publication, Common Stock and Uncommon Profits, published in 1957, placed a premium on companies that were able to grow exponentially versus companies that were simply undervalued. The reasoning is simple; from Fisher in Common Stocks and Uncommon Profits:
“The reason why the growth stocks do so much better is that they seem to show gains in value in the hundreds of per cent each decade. In contrast, it is an unusual bargain that is as much as 50 per cent undervalued. The cumulative effect of this simple arithmetic should be obvious.”
Graham and Fisher are two towering pillars of investment philosophy that have influenced the course of investing for nearly a century and, today, publicly traded equities are often categorized as growth or value investments. However, the prudent investor does not subscribe to one of these two philosophies but, rather, is focused on marrying both.
It is through this lens of investment that we can seek to assess Daryl Morey’s roster construction philosophy with the Houston Rockets during the James Harden era.
The Illusion of Diversification
In many ways, the small number of players an NBA roster has in relation to other major professional sports is in line with what constitutes an investment portfolio that outperforms the market. Diversification is important in a portfolio – up to a point. Having 20 different stocks all of equal weight and across various sectors, for instance, may never perform better than an exchange-traded fund that tracks the Dow Jones Industrial Average or S&P 500. Warren Buffet once said that “diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.” In essence, having a portfolio of 10 stocks in companies that have an investable track record and promising growth prospects has a greater chance of outperforming the market because one is not owning the most but rather the best.
NBA rosters allow for 15 players, but, even then, only 5 players can impact the game at any given moment in time. In contrast, those numbers for an MLB roster are 40 and 9, respectively, while for an NFL roster they are 53 and 11, respectively. Further compounding an NBA’s roster lack of diversification is the fact that basketball is essentially a one-on-one game within a team setting – the ball can only be handled by one player at a time. Because of this, the success of an NBA team is often dictated by whether it has a star player (or two or three!) on its roster.
The star player is the roster investment an NBA general manager ultimately wants to hold onto for the long-term. From Fisher’s Common Stocks and Uncommon Profits:
“I don’t want a lot of good investments; I want a few outstanding ones. If the job has been correctly done when a common stock is purchased, the time to sell it is almost never.”
While holding onto a player in the NBA for “almost forever” is obviously not a feasible endeavor, having a star player on one’s roster for as long as possible is paramount to keeping a team in contention. Much like wanting to be overweight in stocks that outperform in one’s investment portfolio, an NBA general manager will end up allocating as a sizeable percentage of the team’s available salary to the star player(s). The question is, how productive do those dollars become?
James Harden’s Value in Comparison to Other NBA Stars
James Harden has obviously been the star player for Houston for the last eight years, and in the age of such fluid superstar movement – Kawhi Leonard has been on three teams in three years, despite winning championships with two of those teams – it is a rarity to see an NBA All-Star stay faithful to a team for that long.
It is often said that a Harden-led offense can guarantee a team 50 wins, and, with the exception of a disastrous 2015-2016 season, that has certainly been the case since Harden’s arrival in Houston in 2012.
Taking a step further, during Harden’s eight seasons with the Rockets and among star players that have been in the league at the same time, only Lebron James has contributed more wins to his teams. However, Harden has been able to generate his wins at a much lower “Cost per Win.”
Similar to Price-to-Earnings (P/E), the most commonly-used metric to evaluate publicly-traded stocks, Cost per Win (CPW) is a metric that can be used to evaluate how productive a player or roster is in relation to wins generated. Put simply, CPW is a player’s salary divided by NBA win shares, a metric used by Basketball Reference that attempts to divvy up credit for a team’s success to the individuals on one’s team. Because playoff success is a defining factor in evaluating a team’s overall success, both regular season and playoff win shares have been included in this analysis.
In his eight seasons with the Rockets, Harden has contributed 126 wins at a cost of $1.38 million per win. Only top players Kawhi Leonard and Jimmy Butler have a lower CPW ($1.29 million and $1.34 million, respectively), though both have only generated 90 and 82 total wins, respectively. Leonard’s 90 wins are impressive, however, in that he was able to contribute to two championship-winning teams over such a time span. Lebron James has had the most success at 132 wins but has done so at a higher CPW in relation to Harden ($1.65 million).
How Much Does James Harden Contribute to the Rocket’s Success?
It is well known that Harden is one of the most efficient offensive players of all time. What is perhaps less known is how consistently productive he has been in relation to his salary during his time with Houston. Akin to an undervalued stock, Harden’s CPW in every season since 2012 has been below the league average even as his salary has continued to grow exponentially over time:
Why Can’t Harden Have an Even Moderately Efficient Star Player Pairing?
Unfortunately, the Houston Rockets have been unable to pair Harden with another star player that can even produce at parity in relation to salary allocated. In his time in Houston, Harden has been paired with Dwight Howard (2013-2016), Chris Paul (2017-2019) and Russell Westbrook (2019-2020). Eric Gordon has been included as well in the below analysis, given he has often been considered the team’s third best option.
Chris Paul’s 2017-2018 season with the Rockets has been the only time when Harden truly had a productive second All-Star in relation to team salary allocated. Dwight’s underperformance had a lot to do with injuries, as well as Westbrook’s first season with the team. Eric Gordon, with the exception of the 2017-2018 season, has underperformed based on the CPW metric, particularly when he was injured for most of the 2019-2020 season. This represents an unfortunate reality for Harden and the Rockets in their eight-year run together.
Competing at the Margins
Still, in line with a value investment philosophy, Morey has been effective in signing undervalued players that have turned out to greatly outperform their salary. Some of the most successful signings to round out the team’s starting lineup during the Harden era have been PJ Tucker, Trevor Ariza and Clint Capela. His playing concerns in the 2018 semi-finals series against the Golden State Warriors aside, Capela contributed significantly to the team’s overall wins from 2017-2019, having even more win shares than Paul with the 65-win 2017-2018 roster.
Contrary to popular belief, the Rockets have been effective in finding players to help the team compete at the margins. It has mainly been poor production relative to dollars from the team’s second stars during the Harden era that has been the critical stumbling block to the team ultimately winning its third championship.
Just How Efficient Have the Houston Rockets been in Allocating Salary?
While the Rockets have not been able to win a championship during the Harden era, it does not negate the fact that the team has been extremely productive and efficient in generating wins:
Only the Golden State Warriors and San Antonio Spurs have more wins from 2012 to 2020, with Houston being the 3rd most efficient NBA team in generating such wins at a CPW of $1.62 million. Much of that success can be contributed to Harden, who, on average, has generated 28% of the Rockets wins each season. Even more impressive, with the exception of 2016-2017, the share of team salary contributed to Harden has never been more than the share of wins Harden has contributed – he has been worth every penny.
But What is the Value of a Championship?
Given the above, it is clear the Rockets and Harden have been relatively efficient and productive in generating wins in relation to the 29 other NBA teams. Many teams would be perfectly content with the success the Rockets have had during the Harden era, and yet the Rockets are not. Since the 2017-2018 season, the team has been “all in” on winning a championship. The reasoning is clear – beyond cementing a star player’s position in the pantheon of all-time greats, a championship can greatly enhance the revenues of an NBA team. Following the first NBA championship of their five-year dynasty, the Golden State Warriors multiplied their revenues by 1.5 times. Indeed, some teams could care less on how much they spend to win a championship. The Los Angeles Lakers’ CPW during the Harden era is $2.81 million, much higher than the league CPW during the same time ($2.09 million), and yet the team may very well be on their way to winning their 17th championship this season. There is undoubtedly a great benefit associated with winning an NBA championship, similar to a charismatic CEO like Steve Jobs or Jeff Bezos who contributes to their company’s value in ways that cannot be quantified in a financial statement.
The Rockets have undoubtedly been a success in these last eight seasons with James Harden, but in a league and media that values a championship ring above all accolades, all that is left for the Rockets to achieve in the Harden era is to win it all. Only then can the team’s investment in James Harden be fully realized.
Sources: The Intelligent Investor, Security Analysis, Common Stock and Uncommon Profits, Warren Buffett shareholder letters, Hoops Hype (USA Today Sports), Basketball Reference, Real GM.
NBA win shares have not been adjusted to reflect the COVID-19 shortened 2019-2020 season. Total win shares for the Boston Celtics, Denver Nuggets, Los Angeles Lakers and Miami Heat are incomplete due to the ongoing 2019-2020 playoffs. Only players that were active from 2012 to 2020 were considered for the “Star Index.” For example, recent MVP Giannis Antetokounmpo was not considered, as he did not play in the league until the 2013-2014 season.
- Total win shares include a player’s offensive and defensive win shares, as defined by Basketball Reference, for both the regular season and playoffs.
- Cost per Win (“CPW”) is calculated by taking a player’s salary and dividing it by Total Win Shares over a given time.
- CPW for a team or the NBA is calculated by taking the total salary over a given time and dividing it by the total amount of wins generated in both the regular season and playoffs.
- % of Team Win Shares for James Harden is calculated by taking Harden’s total win shares and dividing it by the win shares generated by his team members each season.
- % of Team Salary for James Harden is Harden’s salary divided by the Rockets’ total salary for the relevant season.