Nick Sleep

"The simple deep reality for many of our companies is the virtuous spiral established when companies keep costs down, margins low and in doing so share their growing scale with their customers. In the long run this will be more important in determining the destination for our firms then the distractions of the day." Nick Sleep

Article: Nomand Investment Partnership Letters

January 2002: We are looking for businesses trading at around half of their real business value. Companies run by owner-oriented management and employing capital allocation strategies consistent with long term share holder wealth creation. Finding all three is rare.

June 2002: I have pointed out that any superior record which might be accomplished should not be expected to be evidenced by a relatively constant advantage in performance compared to the average. Rather, it is likely that is such an advantage is achieved, it will be through better than average performance in stable or declining markets and average, or perhaps even poorer than average performance in rising markets.

- When there is a stock market boom, and everyone is scrambling for common stocks, take all your common stocks and sell them. Take the proceeds and buy conservative bonds. No doubt the stocks you sold will go higher. Pay no attention to this – just wait for the depression which will come sooner or later. When the depression or panic becomes a national catastrophe, sell out of the bonds (perhaps at a loss) and buy back the stocks. No doubt the stocks will go lower still. Again, pay no attention. Wait for the next boom. Continue to repeat this operation as long as you live, and you’ll have the pleasure of dying rich (Fred Schwab).

June 2003: Quality of managerial character is therefore important to avoid capital miss allocation and it is in the search for such character that we asked an investment bank to perform a simple company search earlier this year. The criterion was for companies with no increase or decrease in shares outstanding in the last 10 years. There were just 7 in the US market with a market cap above $50M.

- The modern investment management generally lacks this ability (flexibility). The system has become rules based and managers are straight jacketed into geography, sector, style, market capitalisation or security type specific mandates. These managers are unable to purchase investments outside their narrow constraints, regardless of the case for doing so.

“Rules are for infants, incompetents, incarcerated criminals and imbeciles – none of whom should have any place in the Erie family” H.O.Hist, the founder of Erie Indemnity”

December 2003: Our aim is to make investments at prices we consider to be fifty cents on the dollar of what a typical firm is worth. Capital allocation by investee companies must be consistent with value creation and, if this is the case, we expect that the real value of the business (the 100 cents value) should grow at around 10% per annum. The effect over 5years will be to compound $1 of value to $1.62 and companies that can build value like this are normally rewarded in the market with fair valuation (i.e. priced close to $1.62). This happy outcome would imply a return from purchase price of around 26% per annum.

- The prime determinants of outcome are price (sticking to 50 cents on the dollar) and capital allocation by management. The first is in our control, that is, it is in our control to be patient and wait for the right price. The second involves a subjective judgement about the quality of management, and an assessment about the sustainability of business returns in the long term. It is these factors that occupy almost all our time.

June 2004: At Nomad we would rather results were more volatile year to year but maximised our rolling 5-year outcome.

- In the office we keep a list of companies assembled under the title super high-quality thinkers. This is not an easy club to join, and the list currently runs to fifteen businesses. Entry is reserved for the intellectually honest and economically rational, but that alone is not enough. The anointed few are there because they have chosen to outthink their competition and allocate capital over many years with discipline to reinforce their firm’s competitive advantage. …Very few companies have the strength to just sit it out, and shrink, as the pressure to grow is often overwhelming. The clamour comes from internally, Wall Street promoters and short-term shareholders.

- The super high quality thinkers are our best guess of these firms whose shareholders could abdicate their right to trade stock (allocate capital themselves) sure in the knowledge that their capital will be well allocated for years to come within the business. This group is a group of wonderful, honestly run compounding machines. We call this the ‘terminal portfolio’. This is where we want to go.

December 2004: …our definition is that a business is worth the free cash flow that it can be expected to generate between now and judgement day, discounted back at reasonable rate. Period.

- On Costco: Membership is available at $45 USD per annum. The act of purchasing membership has the effect of raising the companies share of mind with the customer in the same way that consumer good companies hope to achieve with conventional advertising. …Goods are priced at a fixed maximum 14% mark up over costs, referred to as everyday low pricing, in order to differentiate it from normal industry practices of changing prices in an attempt to influence traffic, or so called high low pricing.

- In order to make money at such low gross margins, Costco must ensure that:

1. Operating costs are very low

2. Wholesale price is as competitive as can be

3. Revenues need to be very high

- In the office we have a white board on which we have listed the (very few) investment models that work and that we can understand. Costco is the best example we can find of one of them; scale efficiencies shared. Most companies pursue scale efficiencies, but few share them. It is the sharing that makes the model so powerful. But in the centre of the model is a paradox: the company grows through giving more back. We often ask companies what they would do with windfall profits, and most spend it on something or other, or return cash to shareholders. Almost no one replies give it back to customers – how would that go down with Wall Street? That is why competing with Costco is so hard to do. The firm is not interested in today’s static assessment of performance. It is managing the business as if to raise the probability of long-term success.

- What characteristics could one bestow on a company that would make it the most valuable company in the world? What would it look like? Such a firm would have a huge marketplace (offering size), high barriers to entry (offering longevity) and very low levels of capital employed (offering free cashflow).

June 2005: How many companies save $5 for their customers for every $1 they keep? (Robustness Ratio) – Costco. Geico is $1 for $1. Amazon? (Look at Chamath P. break down of this on twitter storm posted in 2021).

- Any year you don’t destroy one of your best loved ideas is probably a wasted year (Charlie Munger).

- 80% Nomads companies are founder managed businesses.

- If you are not disciplined in the little things, you will not be disciplined in the big things (Li Lu)

- Total and complete work (Li Lu)

June 2008: The point of equity is that it is the only permanent capital on the balance sheet. It is there to weather storms, such as the current economic backdrop and provide a stable base, and of course to earn the rewards of enterprise.

- When someone says he is busy, he means he is incompetent (Nassim Nicholas Taleb).

Having a stupidly busy schedule isn’t a sign of being important. It means you have become insulated from the world (Nassim Nicholas Taleb).

- All the busy behaviour looks short term efficient but, in our opinion, the cost is that things are not being thought through; the end result of a thousand small steps in the current direction not assessed and long-term bad habits creep in. The biggest mistakes are the ones that did not look like mistakes at the beginning.

- If businesspeople are too busy to notice that their use of everyday language has drifted into, lets face it, low level lying, how were they to be honest with themselves to recognise the inevitable asymmetry embedded in securitised mortgages?

- In our opinion we have the right environment to think things through, think rationally, and come to meaningful long-term insights.

- Of such stuff are dreams made. Now, let me rephrase this story from the perspective of an equity investor. The collector thought outside the box, rolled up his sleeves, did some proprietary analytical work, and found a contrarian investment opportunity with great potential that few of his peers recognised at the time, lucked into a low price, owned it forever and, in the end, it did not matter what price he paid particularly, as the growth in underlying value made his purchase one of the best investments of all time.

- There are very few business models where growth begets growth. Scale economics turns size into an asset.

- When investors value a business they have in their mind, consciously or not, a decision tree with the various branches leading to all possible futures and probabilities attached to those branches. The share price can be thought of as an aggregate of the probability weighted value of these branches. The problem, as Santa Fe Institute scientist Ole Peters most recently pointed out (SFI Bulletin 2009, Vol 24) is that this is not an accurate representation of what the future will be! The next step for the company will not be to visit all of those branches simultaneously. In reality the firm in question will only visit one of these branches, before proceeding o the next and so on. Short term investors spend their time trying to handicap the odds at each branch. Guessing which branch next can be a crowded trade, but it’s fine, as far as it goes. However, it rather misses the big picture, in our opinion. We would propose that some businesses, once they have progressed down the first favourable branch, stand a much greater chance of progressing down the second favourable branch, and then the third, as a virtuous feedback loop builds. The process takes time, but a favourable result at any stage increases the chance of success further down the line, as it were. Think of it as a business culture.

- If we had our time again, we would hope not to be seduced by their (apparent) mathematical cheapness but weigh more heavily their DNA if you like.

- One trick Zack and I use when sieving the data that passes over our desks is to ask the questions: does any of this make a meaningful difference to the relationship our businesses have with their customers? This bond (or not) between customer and companies is one of the most important factors in determining long-term business success. Recognising this can be very helpful to the long-term investor.

- The simple deep reality for many of our companies is the virtuous spiral established when companies keep costs down, margins low and in doing so share their growing scale with their customers. In the long run this will be more important in determining the destination for our firms then the distractions of the day. (AMAZING!)

Here ends the sermon.

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