Thursday, September 29, 2016

Where are the customer's yachts?

[a book review by Kyle Ferguson]

Earlier this year, I attended my first Berkshire Hathaway meeting that was held in Omaha. During the meeting, Warren Buffett described a book, which he claimed that he read back in 1940 when he was 10 years old, called “Where are the Customers' Yachts?" or "A Good Hard Look at Wall Street."

The book is a fairly fast read at 170 pages. The book was originally published in 1940. It is interesting to note that certain human behavioral tendencies remain the same some 76 years after the book was originally published.

The author, Fred Schwed Jr., challenges the reader early on in the book to answer six questions to determine whether or not they could handle a career on Wall Street.
  1. Do you perceive quite clearly what is the objection to playing a roulette wheel that has two zeros on it? (If not, don’t bother to be a financier; be a roulette player.)
  2. If a man has tossed a coin “heads” four times in succession, which do you think he is more likely to toss the fifth time, heads or tails? (If you think he is more likely to toss either heads or tails, look into the interior-decorating game. You have that instinctive type of mentality which might do very well at that.)
  3. When do you consider that it is a good purchase to draw one card to an inside straight? (Answer when you are playing for soybeans.)
  4. If you have answered (3) correctly, do you find that when you are actually playing poker for money, you can always resist making that draw? (If not, stay home with your money and start practicing being a miser.)
  5. If a stock which is not paying any dividend is split two for one, how much good does that do the stockholder? (If you think it does him any real good come down and join our sales department, but steer clear of our trading department.)
  6. What is the primary purpose of a business enterprise? This question is specifically for young men considering entering the banking field, where they will have a constant parade of business propositions passing before them, and they will be required to plump for a few of them and say “no” to the others. The answer is elementary and obvious: the primary purpose of a business is to make money.
At the time the book was written, there wasn’t the same modern day information that we have available today. During the 1920’s-1930’s, many people irrationally believed that the best stocks were the ones that were the most talked about and the most expensive. These thoughts occurred before a lot of modern day ratios were invented. A time before modern technology had evolved, and before financial ratings such as the Piotroski F-Score, the Altman Z-Score, and the Beneish M-Score were all invented. These scores and rating give modern day investors a much bigger advantage, which allows them to use rational thought, as well as statistical analysis on their investments that enable them to make the “best” most calculated decisions. Instead of irrationally believing that a company is the “best” because it is trading at a high in price or because it is the most talked about security.

Schwed talks about a large number of people set to play a game of pure chance against each other.

“Let us have 400,000 men (and women) engage in this contest at one time. (Something like the number in this country who try being speculators.)

We line them up, facing each other in pairs, across a refectory table miles long. Each player is going to play the person facing him a series of games, the game chosen being a matter of pure luck, say matching coins.  Two hundred thousand on one side of the table face 200,000 on the other side.

If the reader is at all mathematically inclined he should cease reading and work out for himself what is now bound to occur. Otherwise:

The referee gives a signal for the first game and 400,000 coins flash in the sun as they are tossed. The scorers make their tabulations, and discover that 200,000 people are winners and 200,000 are losers.

Then the second game is played. Of the original 200,000 winners, about half of them win again. We now have about 100,000 who have won two games and an equal number who have been so unfortunate as to lose both games. The rest have so far broken even.

The simplest thing from now on is to keep our eyes on the winners. (No one is ever much interested in the losers, anyway)

The third game is played, and of the 100,000 who have won both games half of them are again successful. These 50,000, in the fourth game, are reduced to 25,000, and in the fifth to 12,500. These 12,500 have won five straight without a loss and are no doubt beginning to fancy themselves as coin flippers. They feel they have an “Instinct” for it. However, in the sixth game, 6250 play on and are successively reduced in number until less than a thousand are left. This little band has won some nine straight without a loss, and by this time most of them have at least a local reputation for their ability.

People come from some distance to consult them about their method of calling heads and tails, and they modestly give explanations of how they have achieved their success. Eventually there are about a dozen men who have won every single time for about fifteen games. These are regarded as the experts, the greatest coin flippers in history, the men who never lose, and they have their biographies written.”

I have been studying Warren Buffett for more than 5 years now. After I read Where are the Customers' Yachts?" I remembered that had his own version of a coin flipping story that can be read here.

I thought that "Where Are The Customers Yachts?" was a good book, and I believe that it was a great help in Buffett’s ability to think rationally starting at the age of 10. The book is filled with wisdom, has some comedic value and I understand why it is one of Warren Buffett’s all time favorite books.



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