#365 Nick Sleep's Letters: The Full Collection of the Nomad Investment Partnership Letters to Partners

Nick Sleep's letters emphasize the importance of understanding a company's underlying reality, or the "engine of its success," by analyzing long-term strategies of founders like Jim Sinegal of Costco, Jeff Bezos of Amazon, and Sam Walton of Walmart. These companies thrived by focusing on cost control and reinvesting efficiencies to benefit customers, creating a compounding advantage. Sleep and his partner Zach, inspired by these principles, concentrated their investments in a few high-quality, honestly run businesses. They argue that true investment success lies in deep, long-term commitment to these compounding machines, rather than frequent trading or diversification.

• Nick Sleep emphasizes the importance of understanding the underlying reality of a company, which he terms the "engine of its success."
• Analysis of Costco, Amazon, and Walmart highlights how their founders designed their businesses for long-term survival.
• All three founders, Jim Sinegal, Jeff Bezos, and Sam Walton, focused on being "honestly run compounding machines," which allowed them to avoid interrupting the compounding process.

"This emphasis that all three founders placed on the long term success of their business allowed them to never make the fatal mistake of interrupting the compounding."

• The key trait adopted by these founders was being "a demon on costs," which provided a competitive advantage that compounded over time.

"Having a lower cost structure than any of their competitors was a competitive advantage that compounded over the decades."

• Nick Sleep realized in 2006 that Amazon’s low costs and efficiency meant that "the game was already over," even if others did not realize it yet.

"Amazon's costs are so low and they're so efficient that the game was already over. Everybody else just didn't know it yet."

• The importance of watching costs and controlling spend is a recurring theme in the podcast and is crucial for developing a competitive advantage.
• Historical entrepreneurs, such as Sam Walton, made cost control an obsession.

"Our money was made by controlling expenses. You can make a lot of different mistakes and still recover if you run an efficient operation, or you can be brilliant and still go out of business if you're too inefficient."

• Nick Sleep and Zach decided to close the Nomad Investment Partnership after 13 years and return cash to investors.
• The success of the fund was attributed to the capitalization of the firms in which they invested, particularly Berkshire Hathaway.

"It appears to all the world that the performance that Nomad has enjoyed over the years was created by Zach and me. That is not the case. As time goes by, the performance that our clients have received is the capitalization of the success of the firms in which we have invested."

• Nick and Zach plan to focus on charitable causes requiring long-term funding, despite leaving the professional investment industry.

"Zach has his various charitable causes, and I have in my mind to set up a center to provide respite care."

• Nick emphasizes the need for patience among investors, which he considers a key advantage for Nomad.
• Nomad’s competitive advantage comes from the capital allocation skills of the managers and the patience of its investor base.

"One of Nomad's key advantages will be the aggregate patience of its investor base. We are genuinely investing for the long term. Few are."

• The relationship Nomad seeks with its investors is different from typical funds, focusing on long-term investment.

"The relationship we seek is quite different. And so the note I left myself on this page is really two ideas, or why I spent two weeks, why I did an episode last week that gives an overview of how Nick and Zach built their investment partnership, and then why I would spend another week reading, you know, 110,000 words of Nick Sleep's investment partnership letters."

• Nick Sleep and Zach analyze successful business models like those of Costco, Amazon, and Stagecoach to understand recurring patterns of success.
• The "cancer surgery approach" by Charlie Munger is discussed, where underperforming parts of a business are cut away to reveal the core profitable segment.

"He says this often works because there's normally a jewel at the heart of most companies that has often been used to fund new ventures."

• Examples include Coca-Cola in the mid-1980s, which was streamlined to focus on its core syrup manufacturing and marketing operations.

"As the poorer businesses were cut away to reveal the jewel that is syrup manufacturing and marketing operation, the shares of Coca Cola rose over tenfold in the succeeding decade."

• Jim Sinegal’s commitment to Costco’s everyday low pricing (EDLP) strategy is highlighted as a core principle that ensures long-term success.
• Sinegal’s insistence on maintaining standard markup, even when offered a better deal, underscores the importance of not breaking the contract with the customer.

"The contract with the customer, which is very low, prices, must not be broken."

• This principle of always doing what is better for the customer in the long term, even if it seems less beneficial in the short term, is crucial for sustained success.

"What Jim Sinegal and other great founders do is they always do what's better for the customer, because if you do that over the long term, that is then what is better for the company."

• A similar story from Walt Disney’s construction of Disneyland illustrates the importance of not compromising on quality and principles.

"You're being a poor communicator. People are okay. Don't you ever forget that. They will respond to it. They will appreciate it."

• Emphasis on the principle of focusing on the main objective.
• Importance of concentrating efforts on the primary goal to achieve success.
• Application of deep insights to business strategies.

"The importance of keeping the main thing, the main thing, the importance of focusing and concentrating."

• Highlighting the necessity to maintain focus on the primary goal for effective performance.

"If it's the single best thought you have ever had in your life, it needs to dominate everything because you're not going to get many insights like that."

• Emphasizing the significance of prioritizing and dedicating time to the best ideas.

"Do not divide your attention. Focusing on one thing yields increasing returns for each unit of effort."

• Importance of undivided attention and focus on a single project for better returns.

• Investment performance as the primary responsibility of managers.
• Assumption that reasonable performance will attract interest and growth.
• Comparison with Jim Sinegal's strategy at Costco.

"Job one, two, and three for your manager is investment performance. Few practice this approach."

• Stating the primary focus of managers should be on investment performance.

"If we just focus on getting the lowest possible price to the customer, if that is job one, two, and three, then the customers will respond with loyalty."

• Drawing parallels between investment strategies and customer loyalty strategies in retail.

• Evolution in thinking about the importance of concentrating investments.
• Reference to the Kelly criterion for investment decisions.
• Historical examples of concentrated portfolios, such as Buffett's early portfolios.

"Opportunities in which we are comfortable to deploy capital are rare, and the highest conviction ideas, the rarest of them all."

• Highlighting the rarity of high conviction investment opportunities.

"The logical extension of this line of thought is that nomad's portfolio concentration has been at times too low."

• Self-reflection on the need for higher concentration in their investment portfolio.

• Identification of companies with exceptional thinkers and capital allocation strategies.
• Criteria for inclusion in the list of super high-quality thinkers.
• Importance of intellectual honesty and economic rationality.

"Entry is reserved for the intellectually honest and economically rational. But that alone is not enough."

• Criteria for identifying super high-quality thinkers.

"Good capital allocation takes many forms and does not necessarily require a firm to grow."

• Emphasizing the importance of good capital allocation over mere growth.

• Need for patience and preparation in investment decisions.
• Importance of doing the work today to be ready for future opportunities.
• Reference to the long-term study of companies.

"The trick is to do the work today so that we are ready."

• Emphasizing the importance of preparation for future investment opportunities.

"You have to be a learning machine. You have to be doing the work now."

• Highlighting the necessity of continuous learning and preparation.

• Discussion on common investment mistakes, such as selling too early.
• Importance of understanding the underlying reality of a company.
• Reference to historical examples of missed opportunities.

"What we are trying to do today is to avoid the Baltimore company's second mistake, which was to sell an equally big stake in Walmart in the 1970s."

• Learning from historical investment mistakes to avoid similar errors.

"One must see an investment not as a static balance sheet, but as an evolving compounding machine."

• Emphasizing the need to view investments as evolving entities.

• Analysis of Costco's business model and factors contributing to its success.
• Importance of low operating costs, competitive wholesale prices, and high revenues.
• Strategy of passing scale efficiency gains back to consumers.

"Operating costs are low, indeed, very low. It is indicative of the paranoia with which the company is run that costs are measured in basis points."

• Highlighting Costco's focus on maintaining low operating costs.

"The wholesale price is as competitive as it can be. The key to negotiating terms is that the number of items in a store, so the skus are fixed at 4000."

• Emphasizing Costco's competitive pricing strategy.

"Revenues will be high if the other factors, number one and number two, are favorable."

• Linking high revenues to low operating costs and competitive prices.

"Costco is the best example we can find of one of them. Scale efficiencies shared most companies pursue scale efficiencies. Few share them."

• Highlighting Costco's unique approach of sharing scale efficiencies with consumers.

• Importance of a long-term perspective in investment decisions.
• Reference to the potential growth of super high-quality thinkers.
• Strategy of holding on to investments for long-term gains.

"Time is a friend of the wonderful business and the enemy of the mediocre."

• Emphasizing the long-term benefits of investing in high-quality businesses.

"The trick is to do the work today so that we are ready."

• Reinforcing the importance of preparation for future investment opportunities.

• Nick Sleep analyzes Costco's business model and its low margins, comparing it with Amazon and eBay.
• Sleep identifies key attributes for a valuable company: large marketplace, high barriers to entry, low capital employed.
• He initially considers eBay as potentially the most valuable company, but later focuses on Amazon.

"The firm is deferring profits today in order to extend the life of the franchise."

• Explanation: Costco sacrifices short-term profits for long-term sustainability.

"In our opinion, a business such as eBay could be the most valuable in the world."

• Explanation: Initial consideration of eBay as a highly valuable business model.

"The answer is Amazon. They just don't know it yet."

• Explanation: Sleep realizes Amazon is the ideal business model, not eBay.

• In the early 2000s, Amazon was underestimated compared to eBay.
• Market cap of Amazon in 2004 was $18 billion, while eBay's was $77 billion.

"For the longest time, people thought Bezos has no chance against eBay."

• Explanation: Early market perception favored eBay over Amazon.

"In today's world we're living in, that sounds silly."

• Explanation: Retrospective acknowledgment of Amazon's underestimated potential.

• Sleep outlines Costco's attributes: cost discipline, intellectual honesty, product integrity.
• Emphasizes the importance of long-term strategies and customer-centric approaches.

"Costco is a cost disciplined, intellectually honest, high product integrity, perpetual motion machine trading at a discount to value."

• Explanation: Summary of Costco's strong business characteristics.

"The best investors aren't investors at all. They're entrepreneurs who never sold."

• Explanation: Successful investors think like entrepreneurs, focusing on long-term business growth rather than short-term profits.

• Sleep stresses the importance of not selling stocks that have long-term growth potential.
• Uses historical examples like IBM and Walmart to illustrate repeated investment mistakes.

"The biggest mistake an investor can make is to sell a stock that goes on to rise tenfold."

• Explanation: Highlighting the critical error of selling high-potential stocks too early.

"It's arrogant to think that you're not capable of making the same mistake."

• Explanation: Warning against overconfidence and the need for humility in investment decisions.

• Amazon's strategy involves continuously lowering prices and reinvesting in customer benefits.
• Bezos's philosophy: short-term sacrifices for long-term gains.

"We have made a decision to continuously and significantly lower prices for customers year after year, as our efficiency and scale make it possible."

• Explanation: Amazon's commitment to lowering prices despite short-term profit impacts.

"Our judgment is that relentlessly returning efficiency improvements in scale economies to customers in the form of lower prices create a virtuous cycle."

• Explanation: Long-term strategy of creating value through customer-centric practices.

• Sleep compares Amazon's potential with Costco, noting Amazon's advantages in the digital realm.
• Emphasizes Amazon's ability to scale quickly and become highly profitable.

"Businesses like Amazon have a shot at being far bigger, quicker, and more profitable than their physical world equivalents."

• Explanation: Highlighting Amazon's scalability and profitability compared to traditional businesses.

"This combination makes us think that we may have a mouse that can turn into an elephant."

• Explanation: Amazon's potential to grow significantly larger over time.

• Sleep discusses the challenge of diversification and the temptation to sell high-performing stocks.
• Advocates for a focused investment approach, similar to how founders invest in their own companies.

"Would selling Amazon today be the equivalent mistake of selling Walmart in 1980?"

• Explanation: Questioning whether selling Amazon early would be a significant investment mistake.

"What if you invested like founders invest? Right. It's 100% Sam Walton, 100% of his net worth was in his company."

• Explanation: Suggesting a concentrated investment strategy akin to how founders commit to their businesses.

• During the 2008 financial crisis, Sleep remains optimistic about investment opportunities.
• Focuses on Amazon's underlying strength and growth potential despite market downturns.

"I know it doesn't seem like it, but I promise you this is the best possible time to be an investor."

• Explanation: Encouraging investment during market lows, emphasizing long-term opportunities.

"Customers respond to incentives like all people do. And Amazon's sharing of these benefits of its scale will make them grow much farther from here."

• Explanation: Predicting Amazon's growth based on its customer-centric strategies and scale efficiencies.

• Amazon's resilience during the 2008 financial crisis highlighted its competitive advantage over traditional retailers.
• Traditional retailers, referred to as "high street peers," relied on heavy discounts to attract customers, which Amazon did not need to do.
• Amazon's consistent low prices and convenience attracted customers even during economic downturns.

"Amazon's high street peers could price their products at net income, break even, and still not undercut Amazon's prices or profitability."

• Amazon's pricing strategy made it difficult for competitors to match its prices and profitability.

"Order volumes at Amazon were 16% higher than the previous year compared to the overall retail industry, which are down 10% in the last few months."

• Amazon's growth during the financial crisis contrasted with the decline in the overall retail industry.

• Scale economics benefit companies in both good and bad economic times.
• Successful investors focus on a few key investments rather than diversifying widely.
• Historical examples show great businesses were built by concentrating investments.

"Scale economics works well in bad economic times as well as good."

• Scale economics provide a competitive edge, especially during economic downturns.

"The church of diversification is seen as an insurance against any one idea being wrong. We would propose that if knowledge is a source of value add and few things can be known for sure, then it logically follows that owning more stocks does not lower risk, but raises it."

• Diversification is not always the best strategy; deep knowledge of a few investments can be more beneficial.

• Investors should deeply understand the central engine of success in a business.
• Historical errors in investment, such as selling IBM and Walmart shares, highlight the importance of long-term holding of valuable stocks.
• Successful businesses often rely on a few simple yet crucial principles.

"You cannot just focus on the outputs. If you do, you're going to sell. You have to really understand the central engine of success."

• Understanding the core principles of a business is crucial for long-term investment success.

"In our opinion, the central engine of success at Walmart was a thrift orientation. So low costs, low waste, fueling growth with the savings shared with the customer."

• Walmart's success was driven by its focus on low costs and efficiency.

• Wise investment decisions are based on evaluating opportunity costs and effort.
• Investors should continuously review their holdings and make decisions based on long-term potential.
• Holding onto successful investments and not interrupting their growth is a key strategy.

"When Zach and I trawl through the stock market these last 18 months, we read 1000 annual reports and visited and interviewed 300 companies."

• Thorough research and understanding of companies are essential for making informed investment decisions.

"The key is to not mess that up. The key is to not interrupt this, these honest compounding machines, which in itself is a decision, a daily decision, not to do anything, and arguably more difficult than to do something."

• Sometimes, the best decision is to maintain the status quo and let successful investments continue to grow.

• Successful businesses prioritize customer satisfaction over beating competitors.
• Internal standards and a commitment to doing what is right for the customer drive long-term success.
• Historical business leaders like Jim Sinegal and Sol Price exemplified this philosophy.

"If you want to be successful, and we do, then you have to be willing to be misunderstood."

• Success often requires unconventional thinking and a strong internal compass focused on customer needs.

"We start with the customer and work backwards."

• A customer-first approach is fundamental to long-term business success.

• Simple human attributes and consistent principles lead to the success of great businesses.
• The business models of past successful companies can still be applied today.
• Learning from history's greatest entrepreneurs can provide valuable insights for modern business practices.

"When we study truly great businesses, we find that very often it has been simple human attributes that have led to their success."

• Human qualities and consistent principles are key to building successful businesses.

"It is interesting to note that the business model that built the Ford Empire 100 years ago is the same that built Sam Walton's in the 1970s, Herb Kelleher's in the 1990s, or Jeff Bezos's today."

• Timeless business models continue to build successful empires across different eras.

• Studying historical business successes provides valuable lessons for modern entrepreneurs and investors.
• Concentrating on a few key investments, understanding business fundamentals, and maintaining a customer-centric approach are crucial strategies.
• Timeless principles and human attributes remain at the core of successful business practices.