#365

Introduction

• Nick Sleep and Zach, after 13 years of running The Nomad Investment Partnership, decided to close the fund and return cash to investors, including selling their shares in Berkshire Hathaway. They attribute the fund's success to the companies they invested in, particularly Berkshire Hathaway, and express gratitude for the impact it had on their clients, mainly charities and educational endowments. (0s)
• The Nomad Investment Partnership generated approximately $2 billion for its clients, and Nick and Zach plan to focus on charitable activities, with Zach pursuing various causes and Nick intending to establish a respite care center. They plan to continue investing privately and for their charities. (42s)
• Warren Buffett responded positively to their decision, encouraging them that life is just beginning. The letters exchanged between Nick Sleep and Warren Buffett are included in a collection of The Nomad Investment Partnership letters written between 2001 and 2014. (1m36s)
• Nick Sleep emphasized the importance of patience and long-term investment strategies in his letters, highlighting that Nomad's advantage came from the patience of its investors and the capital allocation skills of its managers. The partnership was designed to be different from typical investment funds, focusing on long-term relationships. (2m20s)
• Nick Sleep and Zach ran their business based on their own thinking and invested in founders who did the same, which contributed to their success. Their approach was characterized by a willingness to trust their own judgment and do the necessary work to achieve valuable outcomes. (3m19s)

The Jewel Approach

• The discussion focuses on the concept of building partnerships around a core "jewel" or valuable aspect of a business, which can often be obscured by less successful projects. (3m40s)
• The analysis of successful business models includes examples from Jim Sinegal's management of Costco and Jeff Bezos's leadership at Amazon, highlighting how gifted founders apply successful strategies across different industries. (3m50s)

Cancer Surgery Approach

• The "cancer surgery approach," as described by Charlie Munger, involves removing unsuccessful parts of a business to reveal its core value, a strategy that has been applied in various business contexts. (4m25s)
• An example of this approach is seen in Coca-Cola's transformation in the 1980s, where cutting away unsuccessful ventures like a shrimp farm and a film studio revealed the profitable syrup manufacturing and marketing operations, leading to significant stock value increase. (4m45s)
• A story involving Steve Jobs advising Nike's former CEO, Mark Parker, to eliminate less successful products and focus on the best ones illustrates the importance of concentrating on core strengths. (5m11s)
• The evolution of Nick Sleep's thinking is explored, showing how he gradually understood and applied the cancer surgery approach in his own business strategies, even before fully realizing its potential. (5m41s)

Costco's EDLP Strategy

• In 2002, Nick Sleep recognized Costco as a well-performing business that did not require fixing, and he aimed to analyze businesses that could grow significantly over time. (6m35s)
• Costco operates on an everyday low pricing (EDLP) strategy, which is a commitment to maintaining low prices consistently. (6m56s)
• The concept of scale economy shared is introduced as a powerful idea that Costco uses to return benefits from their scale to customers through lower prices, encouraging growth and extending scale advantages. (7m52s)
• A story illustrates Costco's commitment to EDLP: when offered a better deal on designer jeans, founder Jim Sinegal insists on maintaining the standard markup instead of increasing it for higher profit, emphasizing the importance of keeping the contract with customers for low prices. (8m26s)
• The approach of prioritizing long-term customer benefits over short-term company gains is compared to Walt Disney's principles during the construction of Disneyland, where Disney refused to compromise on quality despite budget and time constraints. (9m31s)
• John Hench suggested to Walt Disney that they could omit the leather straps from the stagecoach, thinking people wouldn't notice the details. Walt Disney insisted on including them, emphasizing that people do appreciate quality and detail. (10m15s)
• Walt Disney's philosophy was that if high standards are maintained consistently, it sets a precedent for the entire organization to follow, similar to Jim Sagle's approach of focusing on providing the lowest possible price to customers. (10m49s)
• Costco's management strategy is described as straightforward but challenging to implement, focusing on delivering the lowest prices to customers to build loyalty and grow the business over time. (11m13s)

Focus and Concentration

• The importance of maintaining focus on core principles and ideas is highlighted, suggesting that the best insights should dominate one's efforts and attention. This approach is compared to the practices of successful entrepreneurs and companies. (11m57s)
• A post by a co-founder of Palantir, reflecting on lessons from working with Peter Thiel, emphasizes the value of concentrating on a single project to achieve increasing returns, rather than dividing attention across multiple tasks. (13m5s)
• Understanding that applied effort has a convex output curve is crucial when considering new market areas, as the opportunity cost of transferring resources from existing projects to new ones is high unless the new area is extremely valuable. (13m39s)
• Extending an existing convex curve is significantly more valuable, and towards the end of a partnership, there is often a heavy concentration in a few key investments. For example, 70% of Zach's net worth was in Amazon. (14m8s)
• Initially, the portfolio holdings ranged from 3% to 7% of the entire portfolio, reflecting a lack of understanding of the importance of heavy betting. This thinking evolved over time. (14m34s)
• Opportunities to deploy capital comfortably are rare, and the highest conviction ideas are even rarer. The challenge is determining how much to invest in each idea, with the Kelly Criterion suggesting that if one is certain of being right, the entire portfolio should be invested in that idea. (14m49s)
• Historically, only the early Buffett partnership portfolios had such high concentration levels, mainly in companies where Buffett was a controlling shareholder. This suggests that the portfolio concentration of Nomad has sometimes been too low. (15m13s)

High-Quality Thinkers and Compounding Machines

• A list of companies titled "super high-quality thinkers" is maintained, reserved for those who are intellectually honest and economically rational. These companies have chosen to outthink their competition and allocate capital with discipline to reinforce their competitive advantage. (15m52s)
• Successful investment strategies do not necessarily require growth. For example, the partnership's investment in Stagecoach was successful due to the firm's shrinking strategy, and National Indemnity's ability to write insurance only when pricing is favorable demonstrates good capital discipline. (16m35s)
• Few companies have the strength to refrain from growth when returns are poor, and questioning companies with poor economics about their desire to grow often results in incredulous responses. (17m7s)
• The focus is on identifying firms whose shareholders are willing to abdicate their right to trade stock, trusting that their capital will be well allocated by high-quality thinkers like Warren Buffett and Jeff Bezos. These firms are described as "honestly run compounding machines." (17m26s)
• The concept of a "terminal portfolio" is introduced, which consists of these honestly run compounding machines. The goal is to align this ideal list with the current portfolio, which currently does not match. (18m3s)
• The preference is to invest in companies that behave well because they want to, not because they have to. If enough of these opportunities are found, it could lead to a situation where minimal active management is needed. (18m51s)
• Investing early in companies like Costco and Amazon is seen as beneficial because time is considered a friend of a good business. As of 2004, two investments have been made in wonderful compounding machines, with Costco being significantly represented in the portfolio. (19m15s)
• There is a belief that over the next decade, high-quality companies may be available at lower prices, and the key is to be prepared by doing the necessary research and analysis now. (19m33s)

Investing as a Minority Sport

• Emphasis is placed on being a "learning machine" and doing the work today to be ready for future opportunities. This involves studying companies and industries extensively to identify compounding machines. (19m52s)
• Successful investing is described as a "minority sport," and there is a discussion about the common mistakes made by peers in the industry. (20m38s)
• Charlie Munger emphasized that being good at investing is a rare skill, largely influenced by behavior, and not widely distributed. (20m50s)
• Nick Sleep referenced Charlie Munger's talk on the psychology of human misjudgment, highlighting that many investors make the mistake of selling successful stocks too early, as illustrated by historical examples involving IBM and Walmart. (21m6s)
• To avoid such investment mistakes, it is important to understand the underlying reality and success engine of a company, viewing it as an evolving, compounding machine rather than a static balance sheet. (22m0s)

Costco's Success Analysis

• Nick Sleep analyzed Costco's success, noting that the company maintains low operating costs, competitive wholesale prices, and a fixed number of store items, which are auctioned to suppliers offering the best value. (22m22s)
• Costco's supplier criteria demand that vendors consistently offer the lowest possible acquisition prices, with non-compliance resulting in permanent discontinuation as a purchasing source. (23m17s)
• High revenues at Costco are achieved by maintaining low operating costs and competitive prices, with scale efficiency gains passed back to consumers to drive further revenue growth. (23m45s)
• Customers at one of the first Costco stores outside of Seattle benefit from the company's expansion and the decline in supplier prices, which helps old stores grow as well. This is due to Costco's model of sharing cost savings with customers. (24m8s)
• Costco is highlighted as an example of a successful investment model called "scale efficiencies shared," where the company grows by giving back to customers, making it difficult for competitors to match. (24m32s)
• The company focuses on long-term success by recycling cost savings to consumers, which lowers the probability of failure. (25m0s)

Amazon's Similar Model

• In 2004, it was noted that Amazon.com might be following a similar business model to Costco, which involves deferring profits to extend the franchise's life. (25m14s)
• Despite criticisms of low margins, Costco's strategy is to defer profits for long-term growth, which aligns with Jeff Bezos's philosophy of "your margin is my opportunity." (25m32s)
• A valuable company would have a large marketplace, high barriers to entry, and low capital requirements, offering free cash flow. Costco possesses some of these attributes but is not the most asset-light. (26m2s)
• The discussion suggests that a business like eBay could be highly valuable, but ultimately, the answer to a successful internet-based model similar to Costco is Amazon. (26m55s)
• In the early 2000s, Amazon was underestimated compared to eBay, with Amazon's market cap at $18 billion and eBay's at $77 billion by the end of 2004. (28m20s)

Costco's Value and the Mistake of Selling

• Nick Sleep's analysis of Costco describes it as a cost-disciplined, intellectually honest company with high product integrity, trading at a discount to its value, and suggests it will perform well. (28m40s)
• Nick Sleep emphasizes that successful investors often resemble entrepreneurs who never sell their businesses, highlighting the mistake of selling stocks that later increase significantly in value. (29m22s)
• The text discusses the common error of selling stocks prematurely, using historical examples like IBM in the 1950s and Walmart in the 1970s, and stresses the importance of learning from these mistakes. (30m4s)
• The idea is presented that the best financial decisions may not always be financial in nature, as exemplified by Sam Walton's focus on building Walmart rather than maximizing stock returns. (30m50s)

Amazon's Dominance and Long-Term Perspective

• By 2006, it became clear that Amazon, not eBay, was the dominant company, reflecting a shift in market perception. (30m58s)
• There is a critique of the traditional economic research methodology, which often assumes that cause and effect occur over short periods, ignoring long-term impacts. (31m14s)
• A longer-term perspective is considered advantageous, as exemplified by companies like Costco and Amazon, which are penalized by public markets for returning scale efficiencies to consumers through lower prices. (31m55s)
• Jeff Bezos, in his annual report, explains Amazon's strategy of continuously lowering prices, which defies conventional mathematical logic that suggests raising prices is more beneficial. (32m15s)
• Although Amazon can predict short-term effects of price reductions, the long-term impact on business over five to ten years is uncertain, highlighting a gap in traditional economic analysis. (33m2s)
• The role of a founder is described as the guardian of the company's soul, with a focus on long-term strategies like returning efficiency improvements to customers, which is believed to create a virtuous cycle leading to greater free cash flow and a more valuable company. (33m38s)

Amazon's Long-Term Investments

• Amazon's strategies, such as free shipping and Amazon Prime, are costly in the short term but are seen as valuable long-term investments. (34m1s)
• The timing of these strategies is significant, as they were implemented when Amazon was not widely purchased, and Nick Sleep and Zach have been in their partnership for half a decade, focusing on a scale efficiency shared model. (34m15s)
• There is a discussion about the long-term value creation process of BAS, with some traders skeptical about its immediate impact on financial numbers. The process is not strictly math-based, and investment spending does not always guarantee success. Judgment-based decisions, as quoted from Jeff Bezos, often lead to controversy but are essential for innovation and long-term value creation. (34m52s)

Amazon's Growth Potential

• The idea is presented that good investing and good business decisions are synonymous. In a 2007 partnership letter, it is discussed how Amazon could improve further, highlighting traits that could allow a business to grow significantly, similar to Costco but enhanced by the internet. (35m58s)
• Key factors for a business's growth include the ability to self-fund growth and increasing barriers to entry with size, which widens the company's moat. Amazon's advantage over Costco is its potential for rapid growth and profitability due to the internet's power law, combined with leadership by a customer-centric founder. (36m23s)
• The potential for Amazon to grow from a "mouse to an elephant" is considered, with questions posed about the future proportion of e-commerce in U.S. retail. In 2006, only 3.1% of retail sales were online, indicating significant growth potential. (36m55s)
• The text reflects on the decision to hold Amazon shares after their value doubled, questioning whether selling Amazon would be a mistake similar to selling Walmart or Microsoft early in their growth. The idea of inverting portfolio construction, starting with a 100% weighting and working down, is discussed, suggesting an investment approach similar to that of company founders. (37m22s)
• Although not advocating for putting all funds into Amazon, it is noted that such a decision would have been highly successful, as Amazon turned out to be a strong performer. (38m15s)

Investing During Crisis

• A decision was made to allocate an entire fund to Amazon, highlighting the difficulty of such a choice with a humorous story about Exxon discovering oil under its own headquarters, illustrating that sometimes what is sought is right in front of us. (38m31s)
• During the 2008 financial crisis, it was noted that the best time to invest is when others are panicking, as Amazon's underlying strength was uncorrelated to its stock price. (39m1s)
• Amazon's growth during the crisis was attributed to its ability to share the benefits of its scale with customers, contrasting with traditional retailers who relied on high-low pricing strategies. (39m39s)
• Amazon's competitors, referred to as "High Street peers," could not match Amazon's prices or profitability even if they priced their products at net income break-even. (40m13s)
• In 2008, Amazon's order volumes increased by 16% year-over-year during the holiday season, while the overall retail industry saw a 10% decline, demonstrating Amazon's resilience and growth potential. (40m42s)
• The concept of scale economics working well in both good and bad economic times was illustrated with a reference to Sam Walton's attitude during a recession, paralleling Jeff Bezos's approach during the financial crisis. (41m9s)

Diversification vs. Concentration

• Diversification is often viewed as a form of insurance against the risk of any single idea being incorrect. However, it is argued that if knowledge is a source of value and certainty is rare, owning more stocks may actually increase risk rather than decrease it. Successful entrepreneurs like Sam Walton, Bill Gates, Andrew Carnegie, and John D. Rockefeller did not diversify their holdings but concentrated on one company, which they did not consider risky. (41m47s)
• A story from the early 1970s illustrates the potential downside of diversification. A fund management company realized that selling their IBM shares 30 years earlier was a significant mistake, as retaining them would have resulted in a stake larger than their total funds under management. Despite this realization, they repeated the mistake by selling their stake in Walmart, which would have been worth more than their total funds 30 years later. (42m32s)
• The importance of understanding the core elements of a business's success is emphasized. It is suggested that focusing solely on outputs can lead to poor decisions, and a deep understanding of the business is necessary. For Walmart, the central engine of success was its thrift orientation, characterized by low costs and low waste, which fueled growth and shared savings with customers. (43m12s)
• The discussion encourages investors to identify modern companies that embody the successful strategies of past giants like Walmart. It also suggests applying these principles to one's own business to achieve long-term growth. The analysis of companies like Walmart and Costco raises questions about whether Amazon could be the next Walmart. (43m51s)

Investment Choices and Inaction

• The decision-making process of wise individuals is highlighted, focusing on opportunity costs and effort. Over the past 18 months, a review of the stock market involved reading numerous annual reports and interviewing companies, leading to four main investment choices: adding to existing holdings, investing in new businesses, investing in growth businesses, or investing in undervalued companies. The preference has been to stick with existing businesses. (44m21s)
• Claran, an investor who wrote "Margin of Safety," was challenged on the statistical significance of Warren Buffett's track record due to his infrequent trading. Claran argued that Buffett's decision not to trade was itself a significant decision. (45m3s)
• The importance of not disrupting successful investments, like those in Berkshire and Amazon, is highlighted as a key strategy. This approach involves making daily decisions to refrain from unnecessary actions, which can be more challenging than taking action. (45m21s)
• Successful investors like Nick Sleep, Zach, and Le Lu focus on studying great companies and industries rather than worrying about other investors' actions. This mindset allowed them to make significant investments in companies like Amazon and Costco. (45m53s)

Customer-Centric Approach

• An unnamed founder, likely Jeff Bezos, emphasized the importance of being willing to be misunderstood and doing things that may not seem sensible to others. The focus should be on starting with the customer and working backward, rather than trying to beat competitors. (46m21s)
• The business philosophy of having an internal compass focused on doing what is right for the customer is discussed. This approach is compared to Jim Sinegal's practices, which were influenced by his mentor Sol Price. (47m13s)
• Jim Sinegal shared a memo from 1967 written by Sol Price with Nick and Zach, which they found significant enough to frame and hang. (48m12s)
• A memo on the office wall emphasizes that while margin is important, it should not compromise the company's philosophy. Margin should be achieved through better buying, selling the right goods, operating efficiencies, lower markdowns, and greater turnover, rather than increasing retail prices. (48m19s)

Scale Economics Shared

• The business case for scale economic shared is highlighted as a key factor in the success of companies like Costco, which has become the most valuable retailer of its type. (48m57s)
• Cultures that focus on small details are difficult to create unless established at a company's inception, as noted by Jeff Bezos. (49m13s)
• The main idea is that simple human attributes often lead to the success of great businesses, and these attributes are timeless and transferable. (49m22s)
• The business model that built the Ford Empire is similar to those used by Sam Walton, Herb Kelleher, and Jeff Bezos, and will continue to build future empires. (50m0s)

Conclusion and Recommendations

• Recommendations are made to read shareholder letters available for free online or to buy William Green's book "Richer, Wiser, Happier" for insights into successful investors. (50m18s)