The Great Investment Guru Poker Showdown
Four brilliant money managers, two top gamblers, a table in Las Vegas and a proposition: The laws of smart poker and savvy investing are one and the same. Pull up a chair and let's deal you in.
By Stephen Gandel

(MONEY Magazine) – Until Bill Miller did it, nobody ever called 76-year-old Walter Clyde "Puggy" Pearson a giant of the investing world. Pearson's formal education stopped in fifth grade. He's a professional gambler. And his only run-in with the market--after dabbling for a few years he bought tech stocks in 1999--ended badly.

But Pearson, who won the World Series of Poker in 1973, happens to be one of the card game's great philosophers. Among his pearls of wisdom is this: "Ain't only three things to gambling: knowing the 60-40 end of the proposition, money management and knowin' yourself." Miller recently called that statement "all you need to know about investing."

If Pearson's homespun adage hardly seems to measure up to, say, Ben Graham's learned tome Security Analysis, consider two things. First, Miller, the only fund manager in history to beat the S&P 500 for 14 years in a row, probably recognizes investment wisdom when he hears it. And second, the similarity between poker and investing has long been Wall Street dogma. Some firms look for card-playing skills when hiring; others use poker to train traders. None other than Peter Lynch, the legendary chief of Fidelity Magellan in the 1980s, has said that poker, of all games, is the most like stock investing.

Having heard so much of this talk over the years, we at MONEY decided to call our poker-obsessed sources' bluff. We invited Miller and three other world-class fund managers--all true believers of the poker-is-investing theory--to show their stuff in a winner-take-all game of Texas Hold 'Em. Played late last year at Harrah's in Las Vegas, the game brought together probably the greatest array of investing talent ever to sit around one poker table. In addition to Miller were fund heavyweights Mario Gabelli, Bill Gross and John Rogers. Their competition: poker pros Johnny Chan, the most recent player to win the World Series of Poker two years in a row, and Jennifer Harman, one of the world's best female poker players and a featured team member on (A death in his family, unfortunately, kept Pearson from playing.) This writer also played, as did editor Alexander Haris.

Who won? And what did we learn about investing? Ah, well. To find out, just ante up some attention and read on.

Bet only when the odds are good

The first rule of successful gambling, says Pearson, is to not gamble (in the strictest sense of the word) at all. No, he's not condemning all games of chance as hopeless. Instead, he means that you should only bet when the odds are clearly in your favor. Or, as he puts it: "You got to know when you have the best of it. A little bit or a lot. I like a lot."

If your odds are too good, of course, no one will take your bet. So even the best situations afford only a small advantage--at best, by Pearson's reckoning, a 60% chance of winning vs. a 40% chance of losing (thus the name of the rule). You won't win every time. But if you are disciplined enough to wager only on advantageous odds, and you do so repeatedly over the long haul, the chances are very good that you'll come out ahead in the long run.

How do you know when you have the 60 end of the proposition? In poker, the starting hands that give you the best odds are those with the biggest number of "outs"--cards that, if dealt, will likely make you a winner. The more outs, the more chances you will win. One hand that Texas Hold 'Em players love because it has a lot of outs is "Big Slick," the starting hand of an ace and a king. It's not much on its own--even a pair of twos beats it--but Big Slick morphs into a formidable hand if another ace or king hits the table.

John Rogers argues that good stocks, similarly, have a lot of "outs"--factors that can potentially make a company's shares appreciate. (For more on what Rogers and the other managers like now, see page 112.) A longtime proponent of value investing, Rogers looks for stocks with depressed price-to-earnings ratios or other similar measures of value, as well as companies going through so-called turnarounds, management shake-ups and new product launches. Investors don't expect much from them, so a lot of things can happen to make such companies perform better than expected.

Take Caesars Entertainment, which Rogers bought in late 2001. With investors fearing fewer people would travel to Las Vegas after the Sept. 11 attack, the stock of the casino company had fallen from a high of $15 to $8. Meanwhile, the company brought in new management and announced plans to refocus on its more profitable properties. Tourists eventually returned to Las Vegas en masse, and Caesars' earnings rebounded. In July of last year, Caesars accepted an offer to be acquired by Harrah's Entertainment. The deal is likely to net Rogers a 150% return.

"You need the will to make creative calls," says Rogers. After that, it's a matter of "patience and discipline--you need them in both investing and poker."


Each player gets two cards facedown and tries to make the best five-card hand using those ("hole cards") plus any of the five shared cards dealt faceup in the middle of the table. Bets are made after the initial two are dealt, and after the third (the "flop"), fourth (the "turn") and fifth (the "river") shared cards.


Hole Cards


• After the deal, all but three players fold. • Harman raises; Gabelli calls (or matches). • Rogers, holding "Big Slick," knows a lot of cards can make him a winner and calls also.

The Flop

• Rogers' thinking pays off when a king appears on the flop. He bets $50. • Gabelli calls. • Harman folds.

The Turn

• A third king is dealt, making Rogers all but unbeatable. • Gabelli bets $100. • Rogers quickly raises to $200. Gabelli calls.

The River

• Nothing changes at the river. Rogers bets $100. • Gabelli folds. • The dealer pushes $950 in chips to Rogers.

Never bet it all on one hand

In poker there are no sure things. Even the best starting hands can be beaten. "You can have 99.99% the best of it, and that one-hundredth of a percent will still jump up and bust you," says Pearson. "You can't jeopardize all your money on anything." That, in its simplest form, is what Puggy means when he talks about "money management."

In investing, of course, this translates into the bedrock principle of diversification. By spreading your investments over a number of types of investments (bonds as well as stocks), sectors, market caps and geographical areas, you enable your portfolio to better weather the ups and downs of the market over the long run.

There's a flip side to Puggy's notion of money management, however, and it too is applicable to both poker and investing. Though you shouldn't bet everything on a single hand, it's often wise to increase your bet when your odds look particularly attractive. Too big or too small--it's a fine line to walk, but one that many of the finest poker players walk skillfully.

It's a principle investors should learn to follow. "The market can move for irrational reasons, and you have to be prepared for that," says bond guru Bill Gross, who manages Pimco Total Return, the world's largest bond fund. On the other hand, "you need to make big bets when the odds are in your favor--not big enough to ruin you, but big enough to make a difference."

Gross played both sides of the dilemma with a series of particularly skillful trades last year. Coming into 2004, bond prices had risen 35% during the past five years, yet most investors remained optimistic about them. To Gross, however, the long rally was worrisome, especially in light of the growing federal budget deficit. He decided to diversify. In February, he announced that he had lost confidence even in his own bond fund (which, given its charter, was not able to radically change course itself) and was selling a portion of his personal stake. The call turned out to be prescient. Bond yields rose quickly in April and May, causing prices to dive.

Then, in early June, Gross switched his stance. Too many investors were worrying too much about inflation, he thought, and had rushed out of the bond market. He started aggressively adding long-term bonds--the ones that gyrate most when rates rise--to his fund. "We got the sense that the economy was going to slow, and that despite everything, bonds seemed attractively priced again," says Gross. Again, his contrarian bet paid off. In the second half of 2004, rates retreated and bond prices rose. Gross' Pimco Total Return fund ended 2004 up 7.4%, beating 71% of all other bond funds.

"You have to look for the market's tells," says Gross, using the term for the unintentional gestures that can betray a poker player's intentions. "To me, the giveaway is when fundamentals like inflation change and prices don't."


Hole Cards


• After the deal, four players stay in. • Harman, with a possible flush, bets $100. • Gross, Gabelli and Rogers match the bet.

The Flop

• Though the flop doesn't help him, Gross bluffs, betting $100. • It works: Harman and Rogers fold. • Gabelli--despite now having two pairs--merely calls.

The Turn

• Gross' gamble pays off when a second king is dealt at the turn. • Gross bets $200. • Gabelli calls.

The River

• Nothing changes when the river reveals an eight of diamonds. • Gross bets $200. • Gabelli folds. • Gross takes a $1,250 pot.

And correct for your weaknesses

Generally speaking, poker players can be divided into four types, or personalities, only one of which consistently ends up the big winner. The first are the Calling Stations. These players stay in every hand and call (or match) every bet. Since in poker there are many more bad hands than winning hands, Calling Stations tend to lose big over time. It's like they've got the 60-40 rule backward. Second are the Rocks, who have the discipline to fold on lousy hands and to play only the best hands. But they never bet all that much money. Rocks tend to win but rarely a lot, because the anteing cost of just buying a look at the initial cards whittles away at their occasional and meager winnings.

Then there are the Maniacs. These players stay in a lot of hands and raise often. Maniacs will win more hands than Calling Stations, because their large bets cause other players to fold. But when Maniacs lose--which they often do, because they play bad hands as well as good ones--they lose big.

Finally, there's the right way to play poker, the way poker is played by successful pros. These players go into pots only with strong hands, and bet a lot when they do. They'll also stay in with a mediocre hand, if they can do so cheaply. Inevitably they still lose some hands on which they bet big. But ultimately the odds work in their favor, and over time they minimize losses and maximize gains.

Bill Miller says those types of personalities exist in the investing world as well. The Calling Stations are the equivalent of what Miller calls "closet indexers," fund managers whose portfolios closely mirror an index but who still charge high fees for active management. As a consequence, they usually underperform the market.

The Rocks are deep value investors. They stick hard by their principles, only buying stocks after prices have fallen and quickly selling when they rise. Deep value funds tend to make money, but they're not stellar performers.

Momentum investors, of course, are the market's Maniacs. When things are going good, momentum investors make a lot of money. But when the hot stocks crash (think Internet shares in early 2000), they record big losses and sometimes never recover.

Miller--like nearly all the best investors--falls into the fourth category. He buys large stakes in the stocks that he thinks have the best chance of outperforming the market, and sticks with them for as long as his initial reasoning remains sound. Take Google. Many market watchers, MONEY included, said Google's initial public offering overvalued the company's shares, at $85 apiece. It was, after all, a young and unproven company. Miller, on the other hand, saw a company with the ability to beat even Wall Street's rosiest estimates. Ignoring skeptics, Miller bought 12% of Google's shares in its IPO, more than any other investor. Seven months later, Google has outperformed expectations and is up 116%. Plus, Miller isn't ready to sell Google yet.

In theory, most of us put ourselves into Miller's style box. In practice, however, we're often ruled by forces within. A Rock is cautious to a fault; a Maniac, dangerously impulsive. The trick, as Pearson's third rule suggests, is to recognize your natural impulses and correct for them. "The first thing a gambler has to do is make friends with himself," he says. "A lot of people go through the world thinking they are someone else."


Hole Cards


• Four players stay in after the initial deal. • Miller, figuring that only one hand could be better than his, raises the bet to $450. • Rogers has that hand. He reraises to $600. • Miller reraises again, to $750. • Rogers calls, as do Harman and Chan.

The Flop

• Dealt a third ace, Rogers bets $300. • Chan and Harman fold. • Miller, realizing that he may face two aces, calls. (Little does he know.)

The Turn

• Nothing changes on the Flop. • Rogers bets $300 again. • Miller calls.

The River

• The last card gives Rogers a full house; he throws in another $300. • Miller, with just two pair, calls. • Rogers flips up his aces and pulls in a $5,400 pot.

And use their nature against them

F. Scott Fitzgerald said, "The test of a first-rate intelligence is the ability to hold two opposed ideas in the mind at the same time and still retain the ability to function." For poker players and investors, maybe we should make it three ideas. Puggy's principles don't exactly contradict one another, but there's sometimes a little friction. ("Money management" alone requires a balancing act.) And none of them are hard and fast rules. Ultimately, they're most valuable as conceptual touchstones for testing ideas or options as they pop up. Neglect any of them at your risk.

Miller, for one, learned this the hard way. Poor money management proved his downfall two hours into the 3½-hour game. (Gross, by this time, had already gone bust.) With $1,950 in chips left, Miller went all in with ace-nine. Gabelli, holding ace-jack, called the bet and went on to win. "I figured you'd fold on that one," Miller said as his last chips were swept from the table. "I almost did," responded Gabelli, "but not with an ace."

Gabelli says Puggy's precept misses one big aspect of the game: Not only do you need to know yourself, you also need to know your opponents. If a Rock raises, you know it's time to fold. But if a Maniac raises, and you have a strong hand, there's a good chance you'll take the pot.

A similar notion informs Gabelli's investing. In the market, you can't know the person with whom you're trading. What you can learn to interpret is the behavior of certain companies, which is why he's always focused on a handful of industries, including media and telecom. In 2000, Gabelli bought a substantial stake in Pulitzer shortly after it was spun off as a stand-alone newspaper company. At the time, much of the world saw newspapers as a dying industry, and the stock, which began trading at $43, soon fell to $34.

Experience told Gabelli otherwise. He knew that large newspapers were still very profitable and believed they could offset competition from upstart Internet companies by launching their own websites. Gabelli was right. In January, Lee Enterprises announced it was buying Pulitzer for $1.46 billion, or $64 a share, giving Gabelli a nearly 100% return.

His wait-and-see approach paid dividends at the poker table as well. One by one, Gabelli picked off the field (or watched as others did it for him) until only he, Rogers and Haris remained. But Gabelli held most of the chips. With few chips left, Rogers went all in, bluffing with a seven and a nine. He lost when two twos dealt in the middle gave Gabelli, with a two in his hand, three of a kind. Haris followed soon after, going all in with a king and a two. Gabelli had an ace and a five. Two more fives hit the table, and the MONEY Poker Challenge was over.

With his $2,400 prize, Gabelli paid tribute to the aspect of successful poker--and investing--that no amount of strategy, skill or smarts can always beat. Some call it luck. Gabelli sees a higher power. "Dear Father," he wrote in the letter that accompanied the donation of his winnings to a Catholic grade school in the South Bronx. "God provides in strange ways."


Hole Cards


• All fold but Rogers, Gabelli and Chan. • Chan raises to $600. • Gabelli and Rogers (who has another Big Slick) match it.

The Flop

• Rogers, dealt a second ace, bets $600. • Chan, also with two aces, raises to $1,400. • Gabelli, now with three sixes, thinks Rogers can't have better than two pairs but doesn't want to scare anyone off; he calls.

The Turn

• That's a scary card, even for Gabelli. If Rogers paired a jack on the flop, he could now have three jacks. • All three players check.

The River

• Rogers and Chan pass. • Neither opponent has bet for two rounds, so Gabelli figures he must have the best hand; he bets $300. • Rogers and Chan call. • Mario takes the $7,300. "Good hand, Mario," says Chan. "I figured you'd raise me," Gabelli says.