Pet Rocks on the Brain

By David Moon, Moon Capital Management
June 12, 2005

In August 1975, Gary Dahl was an ad executive in California. Ad executives are in the idea business and in August 1975, Dahl had an idea. The United States had just withdrawn from a ten-year, non-declared war in southeast Asia. A president had resigned. An OPEC oil embargo of 1973 precipitated long lines at the gasoline pump. Our country was in a funk and needed something to cheer us up. ('Funk' is a technical economic term.) So out of a sense of patriotic duty, I'm sure, Dahl wrote a press release and sent it to every major media outlook in the country touting his new 'make-you-happy' product: the pet rock. He bought a booth at a San Francisco gift show to show his $3.95 home companion. Newsweek published story. Dahl appeared on the Johnny Carson Show. Even Neimen Marcus carried the rock.

At first, sales were slow. But as the television and news stories proliferated, so did the revenues of Dahl's little venture. Within six months, one million pet rocks had been sold. If Dahl could maintain his average monthly growth rate for only five more years, by 1981 he would sell more than 160 quadrillion pet rocks. That is the equivalent of 42 million rocks for every man, woman and child on earth.

Something happened on the way to the marketing Hall of Fame, however. Americans came to their collective senses and Gary Dahl's 15 minutes of fame were up. He never did sell 42 million pet rocks to everybody on the planet, but he did make a very nice profit for his idea.

No one would ever extrapolate a trend like the first 6 months sales of pet rocks, would they? Well, yes they would. In fact, investors do it regularly. In 1992, Wal-Mart shares were priced as if the company's extraordinary growth rate from the previous 20 years would continue for the next 20. The only problem, however, was that if Wal-Mart could maintain that growth rate for another 20 years, by 2002 its revenues would be greater than the Gross Domestic Product of the United States. Wal-Mart is good, but not that good. Five years later, the shares were trading below the 1993 price, after waiting half a decade for earnings to catch up with an irrationally priced stock.

Do you think that was a rare occurrence? Hardly. We don't need to look any further than Wal-Mart to see it happen again. From 1997 to the beginning of 2000, Wal-Mart's stock price increased 700 percent. Once again, investors expected Wal-Mart to sustain growth that was mathematically unsustainable. In the five years since 2000, Wal-Mart shares have provided investors a return of negative 28 percent.

If you keep making the same mistakes, you're likely to get the same results.

There is nothing wrong or broken at Wal-Mart. During the five years that the stock price declined 28 percent, its earnings increased 63 percent. The value of the company increased while its price declined. That happened because in the years leading to 2000, investors drove up the price of the stock faster than earnings increases could justify.

In hindsight, none of this makes sense. We can look back and realize that when the price of an investment becomes disconnected from its value, the condition eventually corrects itself. The key is to make the observation while it is actually happening, not in hindsight.

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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