Many moons ago Native Americans used to hunt bison or buffalo in a rather barbaric manner. This painting depicts the mechanics of a buffalo jump.
As the image shows, hunters herded the buffalo and drove them over the cliff. Inevitable broken legs rendered the animals immobile. Tribe members waiting below closed in with spears and bows to finish the kills. The Blackfoot Indians apparently called the buffalo jumps "pishkun", which loosely translates as "deep blood kettle".
Investors may read the weekly articles published by Dr. John Hussman at hussmanfunds.com. Dr. Hussman is a brilliant man who studies market cycles using quantitative analysis. It is safe to say that Dr. Hussman's approach to investing is evidence based. This week, Dr. Hussman has the following to say about Ockham's razor.
Ockham's razor is a principle that states that among various hypotheses that might be used to explain a set of observations, the hypothesis - consistent with the evidence - that relies on the smallest number of assumptions is generally preferred. Essentially, the razor shaves away what is unnecessary and retains the most compact explanation that is consistent with the data. The same basic principle runs through the history of thought from Ptolemy ("We consider it a good principle to explain the phenomena by the simplest hypothesis possible") to Einstein ("A theory should be made as simple as possible, but not so simple that it does not conform to reality").
Suppose, for example, that one periodically sets hot cherry pies near the window to cool, and sometimes they disappear, with an empty pie tin usually later found in the kids' treehouse, and cherry stains around their lips. When pies go missing, one would normally not assume that aliens had come down to earth, taken the pie, devoured it in mid-air, brushed by the kids' lips leaving cherry stains in the process, erased the kids' memory, discarded the tin in the treehouse, and then returned to Xenon.
When we observe the increasingly tortured arguments that "this time is different," we see investors discarding straightforward explanations that are fully consistent with the evidence and opting instead for the aliens-from-Xenon theory.
Herbalife (NYSE:HLF) investors were treated to an interview yesterday between Quoth the Raven (no, not me) and Sammy Antar published here on Seeking Alpha. The title of the article could have simply been "I smell buffalo chips."
Put another way, when something sounds too good to be true it usually is. Isn't the yellow brick road's ultimate destination a lesson in self-reliance and the suspension of faith?
Pershing Square also published another expose of yet another Herbalife recruiter at herbalifepyramidscheme.com. There is nothing royal about Kansas City resident Brad Harris' recruiting techniques nor his constant marketing of a mathematical fallacy to Herbalife recruits. I suggest all investors read this information published by Pershing Square's crack analytical team. (As I write this yet another expose has been published featuring Tish Rochin and Larry Thompson)
Herbalife's public filings tell us that Herbalife has successfully recruited over 8 million distributors since the beginning of 2008. This is a data point that is irrefutable. We also know that well over 5 million of these individuals resigned from the company's salesforce over the same time frame.
Meanwhile, Herbalife's most senior and polished and prolific recruiters continue to sell a "proven, step by step, business opportunity" to de novo people around the world every single day.
Q. What on earth is going on?
Why does a successful consumer products company constantly need to replace its salespeople?
Why do so many supposed "discount customers" quit using this dynamic product portfolio so rapidly?
How do the company's executives and shareholders earn such statistically deviant incomes and returns on capital without attracting hyper-competition from companies like Unilever or Abbott?
Why do the company's expensive products only seem to sell well in zip codes with the lowest per capita income in the country?
Why does a company that sells a simple protein shake mix require so many paid endorsers on the payroll to try to establish the firm's legitimacy?
And finally, why do people like Mr. Icahn and Mr. Stiritz tether their well-earned reputations to a company that has such an obviously high rate of business failure for its supposed business partners?
Q. How can this all be explained? What possible hypothesis, as per Ockham's Razor, is the "best fit"? HMMMM!
Faith is the belief in something without evidence. Reason is the study of evidence in order to arrive at a conclusion.
Imagine yourself in a time machine that takes you back to the Great Plains hundreds of years ago. Imagine yourself witnessing a stampede of buffalo hurtling towards a cliff. Behind them, you see on horseback a group of expert hunters corralling their prey. Before the buffalo actually reach the edge of the cliff, isn't it likely that you would conclude that their fate is sealed? Isn't their result pre-determined? Tragically, the answer is probably "Yes"
Are the buffalo really any different than Herbalife's most recent recruits? Aren't the likes of Brad Harris and Doran Andry and John Tartol and Michael Johnson the hunters? Aren't all the people at the bottom of the pay plan just the latest waves of recruits destined to go over the cliff?
Q. What does the data lead us to conclude?
Herbalife recruited over 2 million people in 2013. This represents over 50% of its salesforce. 50% of its people are brand new to the company. Most of these people will fail. Even as they sign-up for Mr. Harris' "step by step plan" or invest in a Nutrition Club to recruit even more people or try to implement the mathematical fallacy that is sold to them - DEEP BLOOD KETTLE is their inevitable economic fate.
Don't believe me?
What if we apply back of the envelope Heather Locklear math to the current salesforce?
If 3.9 million salespeople recruit two friends and they recruit two friends and so on and so on and so on...how many "friends" would Herbalife have?
3.9 million x 2 x 2 x 2 x 2 x 2 = 125 million salespeople around the world.
In the words of Rick Moranis' character Dark Helmet from Mel Brooks' Spaceballs that sort of math is "LUDICROUS SPEED"
This is what the mathematical fallacy Herbalife recruiter's sell looks like "in practice". This is what should happen if all of Herbalife's salespeople follow the step by step plan of success which is supposedly as easy to do as cracking an ATM PIN # that starts with 1-2-3-4 and has only 4 digits.
And yet how quickly most of these new optimists charge of a cliff with proverbial broken limbs and emptied wallets.
Reasonable people don't sign-up for MLM scams. Reasonable people don't buy-in to pyramid schemes. Reasonable people don't try to victimize their fellow man with a confidence game that is rigged. Reasonable people don't sell hopes and dreams and fiction to the world's economically challenged in the name of pseudo-scientific nutrition.
Mr. Icahn has faith that the FTC doesn't have the stomach nor political will to tackle Herbalife. He has said as much live on CNBC. This point of view may turn out to be a BLOCKBUSTER of an error.
The simplest and most logical explanation for how Herbalife operates its business "in practice" is straightforward.
Herbalife operates one of the slickest, most sophisticated affinity fraud pyramid schemes in the history of the world. Participants focus their energy and efforts on recruiting because that is the quickest and easiest way for them to get paid. An endless chain of recruits is constantly being churned and replenished. A new sucker is literally born each and every moment regulators allow this carnival game to persist.
Chasing the herd, so to speak, are the forces of science and reason and logic. Even the casual observer can see what is going on here.
The reason so many investors and executives are dining on buffalo meat is because the buffalo get slaughtered by the economic forces unleashed by the "inherently deceptive" (Koscot) pay plan.
Only time stands between now and the scam's inevitable interruption.
The sooner regulators act to prevent more buffalo from roaming in the wrong direction, the better.
Disclosure: The author is short HLF. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.