The two winning tickets from the UK’s largest-ever National Lottery jackpot on Saturday ensured their owners enjoyed a pretty good start to 2016. 
Even so, the £66m they will split between them begins to pale a little when set against the $1.5bn (£1.04bn) that could potentially be scooped by just one lucky soul when the US Powerball lottery draw is made later today.
This is not the largest lottery in history – Spain’s annual Christmas draw ‘El Gordo, which translates as ‘the Fat One’, shared a prize pool of €2.24bn (£1.68bn) among thousands of winners last month and some €2.5bn among thousands more the year before – but it would, by some distance, be the biggest jackpot for a single person.
All they would have to do is defy odds of roughly 292 million to one.
To put that in perspective, your chances of winning the UK’s National Lottery jackpot lengthened from roughly 14 million to one to 45 million to one when 10 extra numbers were added last autumn.
You are more likely to draw a royal flush in poker (35,000 to one), be hit by lightning (one million to one) or even be bitten by a shark (11.5 million to one – but presumably longer if you never swim in the sea).
Even if someone did defy the odds and wins the Powerball jackpot earlier this week, their decision-making will not have stopped once their numbers were picked. The winner is going to have to decide whether to take the $1.5bn in 29 annual instalments or settle for an immediate pay-out of just the $930m.
There are, of course, bigger headaches to have.
As it happens, this is not the only lottery story to have emanated from the US in recent days.
Back in 1984, Michigan man Donald Magett won a lottery that ensured he would receive $12,000 a year for the rest of his life. Magett later went bankrupt and, earlier this month, the right to all his future annual payments was auctioned so his debts could be paid off in full.
The winning bid was a little over $40,000 and the twist to the story is the bidder will only receive the annual payments for as long as Magett, who is now 73, stays alive.
To put it bluntly then, the bidder is betting on how long Magett will live and, if he is in average health and all other things being equal, the US actuarial life tables suggest this will be for about another 12 years.
Now, although we would naturally be very wary about mentioning investment in the same breath as a lottery or indeed any other form of gambling or speculation, we cannot help but have our professional interest piqued by the very different rates of return that are potentially on offer from these two scenarios.
For, while the expected rate of return for anyone queuing up to buy their Powerball tickets in the US in last week is all but zero, should Donald Magett prove the actuaries right and live for another 12 years, the person who now owns the rights to all his future $12,000 payments will see an annual return of some 30 per cent on their $40,000 bid.
Without wishing to labour the point, we do not speculate – we invest using a tried-and-tested, disciplined value framework.
Still, there are some interesting parallels between that second lottery-related scenario and what we do – insofar as we weigh up the future expectations of what could happen to businesses and make investments when the probabilities are in our favour.
As coincidence would have it, the same year Donald Magett had his ‘cash-for-life’ lottery win, Warren Buffett published an article, ‘The Superinvestors of Graham-and-Doddsville’, in which he set out to rebut an argument that had been gaining currency at the time – that markets had become so efficient value investing was effectively dead.
In it, Buffett imagines a contest where the then 225 million US population each pay $1, flip a coin and, if they call correctly, they win $1 from one of the losers and go on to flip again the next day.
As time passes, the contestants’ numbers fall and the stakes rise so that, after 20 days, the remaining 215 people each have a little over $1m – and a fairly high opinion of their coin-flipping abilities.
Buffett argues that, while many of these 215 will have just been lucky – and indeed the odds are that 225 million coin-flipping orangutans would have achieved the same result – it is possible that, after 20 days of flipping, some of the contestants may well have worked out how to play the odds and to use the probabilities in their favour.
Performance of indices
Source: FE Analytics
As you might imagine, Buffett likens this group to value investors and rams his point home by running through nine value-oriented investors who had consistently beaten the market over time.
“These are nine records of ‘coin-flippers’ from Graham-and-Doddsville,” he writes.
“I haven’t selected them with hindsight from among thousands. It’s not like I am reciting to you the names of a bunch of lottery winners – people I had never heard of before they won the lottery. I selected these men years ago based upon their framework for investment decision-making … Some of them hold portfolios with dozens of stocks; others concentrate on a handful. But all exploit the difference between the market price of a business and its intrinsic value.”
Lottery money can do great things – quite literally, in fact, as it actually helped fund the building of the Great Wall of China.
Still, while somebody in the US may well have seen their dream become reality this week – and then some – those who prefer their odds a great deal more realistic than 292 million to one should consider making the move to Graham-and-Doddsville.
Andrew Evans is a fund manager in Schroders’ UK value team and writes at The Value Perspective. The views expressed here are his own and shouldn’t be viewed as investment advice.
