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