Where Are the Customers' Yachts?

A book review of one of Warren Buffett's favorite books

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Sep 26, 2016
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Earlier this year, I attended my first Berkshire Hathaway (BRK.A, Financial)(BRK.B, Financial)Â meeting that was held in Omaha. During the meeting, Warren Buffett (Trades, Portfolio) 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. It is also clear that our stock analysis through modern information and technolgy has evolved 10-fold compared to the information that was being used nearly eight decades ago.

A Little Aptitude Test

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.

I believe that these are very good questions. You should never be gambling on roulette unless you know that your odds of hitting red or black are 47.4%, not 50/50. Casino games, in general, have a negative expected value, and should only be played for entertainment purposes with the expectation of losing money.

If a man has tossed heads four times in a row, that does not make it any more or less likely that heads will fall again, but we will get to that later. With regards to questions 3 and 4, as I stated in an earlier article, gurus Bill Gates (Trades, Portfolio) and Carl Icahn (Trades, Portfolio) honed their instincts, as well as their ability to think rationally, through the game of poker. It is no surprise to me that Schwed would connect poker to Wall Street. I believe that emotional intelligence, and not being results oriented, should also be on Jason Schwed’s list of questions because sometimes things can happen in the stock market that are outside of our control.

Stop Making Your Own Mistakes

Schwed discusses using an investment trust for investing because the average investor has no excuses except for purchasing investment-trust shares. During the Berkshire Hathaway annual meeting that commenced in late April, Warren Buffett (Trades, Portfolio) said he recommended that investors purchase stock in the Standard & Poor 500, and hold onto it for the long term. In fact, Buffett made a $1 million wager against Protégé Partners in 2008 stating that the specialized asset management firm would be unable to outperform the Standard & Poor 500 over a period of 10 years. You can read more about the wager here.

Hire People That Are Experts in Their Industry

Schwed uses the analogy of investing as an amateur compared to hiring a golf expert to make your shots for you.

“The question may be put this way, using golf again: if it was very important to you to win the class B championship at your country club and the rules permitted you to hire Gene Sarazen, at a reasonable fee, to make the shots for you, wouldn’t you be an egotistical fool to insist on playing the shots yourself?"

If you don't have the time to commit to investing full time, then it makes a lot more sense to hire an expert or follow gurus' trades to ensure that you have the best possible chance of making profits.

The Trouble With Selecting the 'Best Securities'

Schwed talks about the irrational thought of “the trouble with the best securities” that took place from the 1920’s to the time that the book was written in 1940. The definition of “best stocks” has changed dramatically in the 76 years that have passed since the book was originally written.

Schwed describes the idea of “best stocks” in the book.

“Those classes of investments considered “best” change from period to period. The pathetic fallacy is that what are thought to be the best are in truth only the most popular -- the most active, the most talked of, the most boosted, and consequently, the highest in price at that time. It is very much a matter of fashion, like Eugenie hats or waxed mustaches."

Schwed then goes on to say,

“A more sober demonstration of the same sort appeared in a brochure issued in 1937. In this calculation, the twenty most popular stocks and bonds on the Stock Exchange are selected at four different periods between 1901 and 1926. The selection of the most popular was made on each occasion by choosing those in which the largest volume of trading occurred in that year. Their cost at that time was figured and compared with their value at the end of 1936. The results were extremely poor, and now three years later, it just so happens that they are a good deal poorer.”

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.

A Brief Excursion Into Probabilities

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

This is another example of success leaving clues. Buffett had the opportunity to learn from someone else’s mental model, and he was able to erase the same irrational thoughts from his mind, enabling him to teach others to think rationally through his own version of the story.

Believing that flipping coins is an actual skill could be added to Charlie Munger (Trades, Portfolio)’s 24 laws of human misjudgements.


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 (Trades, Portfolio)’s all time favorite books.

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