Humor me, make me rich

By DAVID MOON, Moon Capital Management
May 8, 2005

Did you ever wonder why they call them 'hot water heaters?' Hot water doesn't need to be heated. What people need is a cold water heater. Or a hot water cooler.
- Comedian George Carlin

There are plenty of traits useful in investing. The ability to be logical and unemotional, to grasp multiple concepts simultaneously, some math skills and a reasonable amount of intelligence are a few of those qualities. And perhaps one of the least obvious personality characteristics commonly found among successful investors is a healthy sense of humor.

Effective humor hinges on looking at everyday situations and seeing the obvious things that are overlooked by others. The comedian shows the audience what we've experienced all along but didn't notice. It's obvious; how could we have missed it? Why did we need George Carlin to point out the silliness of calling it a hot water heater?

A little more than five years ago, the U.S. stock market traded at ridiculously high prices. In hindsight, it is obvious that the general level of prices was ridiculous. But it took a nasty joke ' in the form of a laughless bear market ' for most investors to see the obvious.

Albert Szent-Gyorgyi, a Hungarian scientist, observed that discovery is seeing what everyone has seen and thinking what nobody has thought. That's what George Carlin does. It's also what Warren Buffett does.

The propensity of most investors to move in the same direction at the same time has generated a familiar put-down: the 'herd mentality of Wall Street.' In fact, the animal/investment analogy goes much deeper. Animals from antelope to zebras travel in packs because the group offers mutual protection from predators. The animals find apparent safety in the herd, just as institutional investors all buying the same stocks do. The investor whose returns deviate the least from those of other investors is like the unnoticeable zebra in the middle of the herd. Hidden in the pack, an animal is safe from external threats; it won't stand out or draw attention.

The problem, however, is that there is very little grass in the middle of the herd. The biggest risk of staying in the middle of the pack is starving to death. The largest and strongest of herding animals are the solitary stalkers and hunters that spend most of their time separate from the group.

It's not just a good eating strategy; it's a good investment strategy.

I once worked in an investment herd. Our company was like the vast majority of similar businesses in our industry: we were in the business of attracting new customer assets. Our executives felt we couldn't attract those assets if our returns last quarter significantly trailed the overall market averages, even if our longer-term returns would have benefited from being willing to accept short-term underperformance.

In that business model, the key to attracting new customers was not investment performance; it wasn't even customer service. We were able to attract new assets because of a vast retail system that touched thousands of customers and could easily generate plentiful leads for the salespeople. But the leads could be useless if last quarter's performance differed significantly from everyone else's. Result? Our portfolio looked very similar to those of most institutions like ours. We ran in a herd. We were well protected from predators, but our portfolios consisted of stocks selected from the bare grass.

With the mind-set of a comedian, we could have looked at the same data and situations as everyone else but seen the 'hidden obvious.' Able to think differently from the crowd, like a comedian, an investor is more likely to separate from the herd. And that's where he'll find the tall grass.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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