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

Transcript from https://podmenti.com/t/456b46f22bcc87a8

One of the most interesting things that Nick Sleep writes about is the importance of understanding the underlying reality of a company. He calls this the engine of its success.
What I actually found most interesting in these letters
Is Nick's analysis
Of the engine of success of Costco.
Amazon.
and Walmart and how those three founders, Jim Sinegal, Jeff Bezos, and Sam Walton
design their business in a way that ensure that they would survive over the long term.
All three of them.
We're what Nick Sleep calls.
Honestly run compounding machines.
This emphasis that all three founders place on the
long term success of their business allowed them to never make the fatal mistake.
of interrupting the compounding.
And to do so, Bezos, Cynigal, and Walton all adopted a key trait. They were, in the words of Warren Buffett, a demon on costs.
Having a lower cost structure than any of their competitors was a competitive advantage that compounded over the decades.
And Nick is going to mention that several times, including one time
When he realizes back in two thousand six
That 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.
This is something that I was talking about with my friend Eric, who's the co-founder and CEO of Ramp. Ramp is now a partner of this podcast.
I've gotten to know all the co founders of Ramp and spent a bunch of time with them over the last year or two.
And they all listen to the podcast, so they've picked up on the fact.
that the main theme from the podcast, one that recurs over and over again.
Is the importance of watching your costs and controlling your spend.
the managers that are able to do so develop a massive competitive advantage. And that is the reason that Ramp exists. Ramp exists to give your business everything you need to control your spending
And watch your cost. All of history's greatest entrepreneurs.
made cost control an obsession. Ramp helps you control costs all in a single platform.
Ramp gives you easy to use corporate cards for your entire team.
automated expense reporting and cost control.
In his autobiography, Sam Walton said, 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.
Ramp helps you run.
an efficient organization and greatly enhances your company's engine of success.
Ramp's website is incredible. Make history's greatest entrepreneurs proud by going to ramp.com to learn how they can help your business control costs today. That is ramp.com.
Dear Mr Buffett.
After thirteen happy years of running the Nomad Investment Partnership.
Zach and I
Have decided to close the fund.
The process requires us to return cash to our investors.
Енсоамені.
as shareholders in Berkshire.
We have recently sold our shares.
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.
In other words.
The real work
Is done by you.
And the good people at Berkshire.
The purpose of this letter is to say a very big thank you.
and let you know that you have made a real difference.
Nomad was not a particularly large fun.
But over the years, it did make around two billion dollars for its clients.
Which were predominantly charities and educational endowments.
Breaks.
was a big part of that.
That strikes us.
as capitalism working well.
For our part, Zach and I are keen to leave the professional industry behind and spend our time in more caring pursuits.
Zach has his various charitable causes, and I have in my mind.

A center to provide respite care.
Both of these activities will require long term funding.
And so while you lose us as professional investors
we will be able to repurchase our shares both privately and for the charities that we run.
You don't get rid of us that easily.
We will be keeping the office.
and a new sign will be hung above our somewhat shabby front door.
We look forward to seeing you at the next AGM and extend an invitation to visit us at Burnsall Street.
With the warmest regards.
Nick sleep.
And then Buffett writes back, Dear Nick.
Thanks for sending along the update. You and Zach have made the right choice. I predict
You will find life is just beginning.
Best regards, Warren E Buffett.
And so those letters appear at the very front of another homemade book.
That I have created. I read.
All hundred and ten thousand words.
This is the full collection.
Of the Nomad Investment Partnership Letters.
They were written to partners between the years two thousand one and two thousand fourteen, and they were written by Nick Sleep.
I printed Nick's letters out.
And put all two hundred and nineteen pages in a binder.
And so I wanna begin with something that Nick repeats and something that he
Leaves at the end of a lot of his
Partnership.
And so he writes A final word on the need for patience. We are aware that several investors are new to the fund.
And so it may be worth reiterating some ground rules so that you know where we stand.
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.
If Nomad is to have a competitive advantage over our peers, we're
This will come from the capital allocation skills of your manager, if any.
And
the patience of our investor base.
Only by looking further out than the short term crowd can we expect to beat them.
It is for this reason we named Nomad an investment partnership.
And not a fund.
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, t a hundred and ten thousand words.
of Nick Sleep's investment partnership letters. And so it's obvious from reading the book last week and then reading
Nick Sleep's letters this week.
They didn't copy their peers.
Nick and Zach ran their business based on the outcome of their own thinking.
And then they invest in founders that do too. And then I would argue that it's their willingness to do the work necessary to trust their own judgment that allowed them to arrive at a very valuable earned secret.
And then the willingness to change their behavior to build their entire partnership around that earned secret. So that's really what I'm gonna focus on.
And I want to talk to you about today.
a lot of what I found interesting in the partnership letters has nothing to do with investing.
It's their analysis of how Jim Sinegal ran Costco. It's their analysis of how Jeff Bezos ran Amazon. It's their analysis of way, this is kinda strange. This business model keeps reappearing throughout history.
And gifted founders are able to use it and apply it to vastly different industries and keep having wild success.
And so Nick writes about Charlie Munger's cancer surgery approach. He's analyzing this business that they made an investment in.
I talked about it last week. It's called Stagecoach.
The founder retires.
new management kind of runs it into the ground so the founder comes back out.
And when you realize like there's this beautiful business under here, but you kinda layered all this crap on top of it.
And so what Munger realized is there's many times in business history where
Well, you just need to do a cancer surgery approach. He says this often works because there's normally a jewel at the heart of most companies.
It has often been used to fund new ventures.
that jewel's been taken for granted by inpatient management. As the jewel becomes diluted
by less successful projects
Aggregate performance declines.
And so Nick talks about the fact that Munger and Buffett saw this in Coca Cola in the nineteen in the mid nineteen eighties because at that time
the Coca-Cola had become a poorly defined conglomerate, including a shrimp farm
Winery.
And a film studio.
As the poor businesses were cut away,
To reveal the jewel that is syrup manufacturing and marketing operation, the shares of Coca-Cola rose over ten fold.
In the succeeding decade.
There's a hilarious story that comes to mind when
The Mark Parker, who's the former CO of Nike, asked Steve Jobs if he had any advice for him.
And Steve said, Nike makes some of the best products in the world, products that you lust after.
They're absolutely beautiful, stunning products, but you also make a lot of crap.
Just get rid of the crappy stuff.
and focus on the good stuff. Just get rid of the crappy stuff.
And focus on the good stuff.
This idea that a jewel can become deluded.
By less successful projects.
as aggregate performance declines.
The reason I started here is because what's fascinating about
Reading these letters, but also in I'm gonna go through these in chronological order.
So we can see the evolution of
Nick sleeps thinking.
It's also the same phenomenon that you and I uh see when you go through a biography.
And you go through somebody's life chronologically.
You see them slowly figure it out, they struggle, and they're trying to really get to the idea.
the main idea and the main focus of their life.
And what's fascinating about reading this part, this is at the very beginning.
Nick doesn't understand. He's describing the cancer surgery approach. He's describing Coca Cola.
He's describing stagecoach. At this point in his life, he doesn't understand he's gonna also use this principle in building
His business.
He is going to take the advice of Steve Jobs, even if he never heard it.
He's going to get rid of the crap which is these other investments.
And just focus on the good stuff.
And he's already stumbled onto a really great business, and this is the beginning of his understanding. He doesn't know how deep he's gonna go in Costco. So this is two thousand two.
He's like, Well, Costco, you know, we just bought the stock.
There's really no need to fix this business because it's performing well already.
And so there's something that Nick will mention later on. He's like, Well
you know, we're trying to analyze b analyze businesses that like are a mouse now but may turn into an elephant
And try to reverse engineer like how that happens. And so
You start to see this at the very beginning when he starts talking about a Costco. He's like, Well
They operate on this everyday low pricing strategy, which he'll refer to moving forward as EDLP.
The way I would describe that is if you have not listened to episode three sixty, listen to episode three sixty.
After you listen to this episode.
Try to find that book.
It is written by Bob Kierlin, who's the founder of Fasinal.
That book and the way Bob ran Fast and all all centers around this one idea.
that the leader of a company has to keep the entire organization
committed to a common goal.
Costco's
common goal is that we are going to commit to this everyday low pricing strategy.
And they commit to it every single minute of every single hour of every single day. As we're about to hear with this great Jim Sinegal story in a minute, but I gotta before I leave this page, this is two thousand two.
And he's just start talking about the scale economy shared, and he's just starting to
try to think about and understand. It's going to take a long time to understand how powerful this idea is.
But he starts talking about this new idea of scale economy shared, which is going to be their
Earn secret.
the single best thought that they ever had, the one that they're gonna let dominate everything that they do.
And so Nick is like, Okay, so Costco is committed to this strategy of
E DLP.
And by them sticking to the standard markup is a way that they
All the benefits that they get from from scale as a company are returned to the customer in form of lower prices, which in turn cur encourages growth and then extends scale advantages.
And it illustrates a level of commitment that the founder has to this idea.
This is what he says to understand how important E D L P is to Jim Sinegal.
Costco's founder consider the following story. So what Costco gets us
Incredial, b uh better deal than they normally get.
When they buy two million pairs designs.
they wind up getting'em for twenty two dollars. So ten dollars less than Costco had sold the jeans for in the past.
So they offer this huge markup. You could essentially mark up another fifty percent.
And you'd still be half the cost of most other retailers.
So one of Costco's buyers recommends taking a higher gross margin than usual.
More than the normal fourteen percent markup.
Since no one would know.
So he says that to Jim Cynigal and Cynig insists on the standard markup.
Arguing.
That if I let you do it this one time, you'll do it again.
The contract with the customer, which is very low prices.
must not be broken.
This is a really important point to consider. Think about this.
What the buyer's trying to do is do what's better for the company. What he thought was better for the company.
At least what was better for the company in your short term.
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?
And so when I read this section, this entire paragraph, I just stared at the page, I was like, I've seen this before.
This reminds me of Walt Disney. So then I go to Founders Notes, I type in the keyword search Disney leather straps.
And what is remarkable is we see a very similar story play out.
When
Walt Disney is building Disneyland. They are over budget.
They don't have enough time. They have a specific date that they have to open by
And so you see this conversation that Walt Disney's having with one of his employees.
And his employee does the same thing. Let's cut a corner here. Let's compromise a principle.
Because short term it's better.
For the company.
At least in their misunderstanding.
And so they're finalizing a ride in funny, it's stagecoaches,'cause they're horse drawn stagecoaches.
Same name as Nick as one of Nick's investments on the previous page.
And so let me read from this book called Disneys Land.
They were among the first of the park's attractions to be finished, but the pressure of time was already weighing on everyone.
One day John Hench stopped by to check the progress on the coaches and had an idea which he brought up to Walt.
Why don't we just leave the leather straps off, Walt?
The people are never going to appreciate all the close up detail.
Disney treated Hench to a tart little lecture.
You're being a poor communicator.
People are okay.
Don't you ever forget that.
They will respond to it.
They will appreciate it.
Hensch didn't argue. He said we put the best damn leather straps on that stagecoach.
You've ever seen.
I think what Walt understood is what Jim
Cynigal said, If I let you do it this time
You'll do it again.
This entire organization is gonna be committed to this one common goal.
Everyday low prices.
Or as Jim Sinegal's mentor, Sol Price, we'll talk about later.
says focus on getting the lowest possible price to the customer always.
So back to Nick's letters. Many retailers do not operate in such a way.
Costco's management describes this strategy as easy understand and hard to operate.
Now a few years later in two thousand four, you see this
This is one of my favorite parts because this is this happening. This should be happening as you know, you're reading more biographies, you're studying more entrepreneurs, studying more companies.
You start to see that their ideas, right? You're applying them to your own business.
And so they're studying all these what they they want to, you know, hopefully think.
And will turn into uh like large, wonderful business businesses. You know, Costco is
Go going to only get a lot bigger from here.
And then they're gonna use the insights that they derive from Costco to make a massive investment in Amazon.
But with this paragraph you can't help but notice that they're oh, they're they're applying it to h the how the businesses that they're building and how they're spending their time.
So this is job one.
Two and three for your manager is investment performance. Few practice this approach. We work under the assumption
That if performance is reasonable.
then the level of interest in what we're doing will increase.
And the partnership will grow in time.
The principle behind what they're saying is very similar to the the same principle that they identified
with the way Jim Sinegal ran Costco. It's like well 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 spawn.
With loyalty.
That will compound over the years and Costco will get bigger just like they said Nomad, the partnership will get will grow in time.
And so the note I have.
is actually longer than the paragraph. So the first thing is
Keep the thing the importance of keeping the main thing the main thing, the importance of focusing and concentrating. And that is related to part two, which is one of my favorite ideas.
When they knew that they had uncovered a deep truth and Nick says
If it's the single best thought you have ever had in your life, it needs to dominate everything.
Because you're not gonna get many insights like that.
And if it's your single best insight, your single best idea, then obviously it's what you should be spending all your time on.
There is a post written by one of the co founders of Palindare. It talks about what he learned from working with Peter Thiel.
And this part of the post I have saved on my phone, and I think it applies to exactly what's taking place here. Do not divide your attention.
Focusing on one thing yields increasing returns for each unit of effort.
At a micro level, an extra hour of focus on the current project
has a much higher return than an hour on something new.
Or worse.
Five minutes.
Each on twelve new things.
Before you ever do something new.
You should understand the opportunity cost versus existing things.
Don't rationalize that something you want to do is complimentary when it's not.
At a macro level, understanding that applied effort has a convex output curve.
Is a very useful discipline.
When considering new market areas.
This convexity means
That the opportunity cost of transferring resources from existing projects
to new ones is high.
Unless the new area is incredibly valuable.
Anything we can do to extend an existing convex curve.
is worth so much more.
And so towards the end of the partnership, they're known for their heavy concentration.
And just three things.
And like you and I talked about last week.
In one case, seventy percent of their net worth. I think this was uh Zach's net worth.
Seventy percent of Zach's net's worth.
was in Amazon. Just one
Stop.
But we're in the two thousand four letters.
And they haven't yet learned the importance of betting heavy yet.
This is what's so remarkable about reading them.
is you see this constant evolution of thinking. So at this point
They have holdings ranging anywhere from at most their highest one is seven percent of their entire portfolio.
Down to point three percent.
And you see that Nick is thinking about this. He's like, Well, this is just like Charlie Munger, Charlie Munger is right.
When he says it's aggravating to jo buy just a little bit.
But this is a hard question to answer. So it says in reality, opportunities in which we are comfortable to deploy capital are rare.
And the highest conviction ideas, the rarest of them all.
The issue then
is how much to invest in each idea.
And this is Nick's takeaway from thinking about the Kelly criterion, the common sense outcome of that equation.
is that if one is certain of being right, one should invest the entire portfolio in that idea.
But does anyone do that?
So he goes back to history. As far as we are aware, only the early Buffett partnership portfolios had anyone near this level of concentration.
And then mainly in companies in which Buffett was a controlling shareholder. But is this not the right way to think?
The logical extension of this line of thought is that Nomad's portfolio concentration is
has been at times too low.
And so in the margin of this homemade book I have, I was like, all right, starting to change their mind.
When do their actions reflect that?
And on the very next page, he has a section called the likely evolution of the partnership investments.
I love this part. I underlined almost the entire part.
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 15 businesses.
Entry is reserved for the intellectually honest
And economically rational
But that alone is not enough.
There are many companies that do the right thing when their backs are against the wall.
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.
Good capital allocation takes many forms.
And does not necessarily require a firm to grow. This goes back to
the Charlie Munger's cancer surgery approach. Okay. So he says
The partnership successful investment in stage coach.
has been due to the firm's shrinking strategy.
Not its growth.
At national indemnity, which is an insurance subsidiary of Berkshire.
The firm's ability to write insurance only when pricing is good.
and stand back when pricing is poor, even if revenues decline, is a wonderful example of capital discipline.
And good
Capital allocation.
After all, why grow if returns are going to be poor?
Surprisingly few companies have the strength to just sit it out.
This part made me laugh out loud.
We ask companies with poor economics why they want to grow.
And senior management look back at us incredulous.
At our line of questioning.
I guess their answer is we'd like to grow so we can lose even more money.
The super high quality thinkers.
Our our best guess as those firms whose shareholders
could abdicate their right to trade stock.
Which means you're advocating the right to allocate capital themselves, right?
Nick is outsourcing that to the Buffets, the Bezos.
The cynicals.
So the super high quality thinkers are the best guest of those firms whose shareholders could abdicate their right to trade stock.
Sure in the knowledge that their capital will be well allocated for years to come.
Within the business.
This list is a group.
Of wonderful
Honestly run.
Compounding machines. That is what he's looking for. Honestly run compounding machines.
We call this the terminal
Portfolio.
This is where we want to go.
The question is
Why is this list
Not the same.
As the current
Nomad portfolio and what I write there.
is answering the question on the previous page and I wrote fucking bingo.
on the previous page, starting to change their mind, when will their actions reflect that?
He's having a very honest conversation. He's like, This is the outcome of our own thinking.
We have this group.
We've identified a a a pot a handful of potential
Honestly run compounding machines.
This is our terminal portfolio.
This is where we want to go.
But then we compare that list to our portfolio, they don't match.
And so then Nick elaborates on the honestly run part of this.
Now he doesn't want just a compounding machine, he wants an honestly run compounding machine. What does that mean?
There are only two reason comp two reasons companies behave well.
Because they want to and because they have to.
Our preference is to invest in those that want to.
If we can find enough of these heavenly opportunities, they will infect
Put us out of a job.
We will be pleased if a little bored.
And he arrives at that conclusion because he's like, Well, if we can invest in them early, we can invest in Costco and Amazon early. We don't have to do anything else because time is a friend of
A good business. In fact
I like the way Buffett put this in his shareholder letters better. He says time is a friend
Of the wonderful business and the enemy of the mediocre.
And so Nick says today in two thousand four
We have made two investments in wonderful compounding machines, and only one of those
is meaningful meaningfully represented in our portfolio. That's Costco.
What is the probability that say over the next ten years a good portion of these super high quality thinkers
Will be priced at fifty cents.
So there's some kind of pullback in the stock, right?
Our betting is that odds are reasonable.
The trick is to do the work today.
So that we are ready.
If you go back to the Li Lu's lecture with the Columbia business school students.
That's what he kept telling.
You have to be a learning machine, you have to be doing the work now. He he referenced many times.
That it takes a long time now, but it makes you go faster later on. But that
You'll study something, he would study like an American company for like fifteen years. It would take him fifteen years to find the Asian counterpart.
Nick is telling us something very similar here.
We're gonna think this through, we're gonna analyze this business model, we're gonna try to find these super high quality thinkers, these compounding machines.
And then we are going to be patient. We are going to wait because the probabilities are high to be able to get a good price to buy in. The trick is to do the work today so that we are ready.
And so in addition to spending time analyzing companies and industries
and trying to find these compounding machines. They also talk a lot about or Nick talks a lot about
All the m uh mistakes that his peers and other people
in uh the industry mate. He says successful investing is a minority sport. When I had dinner with Charlie Munger,
I have a list on my phone.
Of all the notes I took.
uh from the conversation and one of the last things that Munger said to me at dinner
was that being good at investing is a very rare skill.
It is not
Distributed widely and will never be. And that has to do with behavior. So Nick Sleep says the best talk on investing wasn't about investing.
And it was Charlie Morger's talk, The Psychology of Human Misjudgment.
And so what Nick is doing here, he's thinking through, he's like, Well
What the problem is what if we're right? What if these are wonderful businesses? What if Costco's gonna get much bigger from here?
Why is it that when you look at the history of investing that so few people cannot see success?
And what he means by that is they sell way too early. So he says we take no comfort from the fact that not seeing success.
is a perennial investment mistake.
In the nineteen fifties, a large Baltimore based fund management company sold their client shares in IBM
Only for the shares to appreciate to the point that the value of the shares
sold would become bigger than the whole fund management company itself. Remember this, cause he tells it uh the the same story many years in the future, and I think he does an even better job. 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 nineteen seventies.
The point he's obviously making is hey, just hold on to IBM and Walmart and you didn't have to do anything else.
So how does one avoid these mistakes? The answer lies in analyzing not the effects and outputs of a business.
But digging down to the underlying reality of the company.
The engine of its success.
One must see an investment not as a static balance sheet.
But as an evolving compounding machine.
And if you did that, you would not have sold Walmart in the nineteen seventies.
And so Nick starts sharing his thinking about
What is the engine of Costco's success? And is there some traits that some actions that it's taking that would cause their customers to maintain this loyalty?
And this commitment to Costco over a long period of time, I told you.
Uh, last week, you know, my wife's family's been shopping there for almost thirty years.
They are extremely committed.
To Costco. So
Nick says number one.
Operating costs are low, indeed very low.
It is indicative of the paranoia.
with which the companies run that costs are measured in basis points.
Number two.
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 four thousand.
And the right to fill one of those spaces is auctioned.
with the supplier that provides the best value proposition to the customer.
winning space on the shop floor. So he talks about
How ruthless
They can be with their
uh suppliers that that on their website it lists the criteria required to become a Costco supplier.
And Nick highlights this one section. We expect all vendors to consistently and voluntarily quote
the lowest possible acquisition price available on all items.
A vendor who does not consistently and voluntarily quote its lowest price to our buyers.
will be permanently discontinued.
as a purchasing source for Costco.
This is Nick's.
Response to that. Gru good grief.
One strike and you're out.
Number three, revenues need to be very high.
Revenues will be high if the other factors number one and number two are favorable.
If operating costs are low.
And prices are as competitive as they can be.
The issue is what the company d then does with the revenue advantage.
In the case of Costco, scale efficiency gains are passed back to the consumer
In order to drive further revenue growth.
That way customers at one of the first Costco stores outside of Seattle
benefit from the fern's expansion into say Ohio.
As they also gain from the decline in supplier prices.
This keeps the old stores growing too.
The point is that having shared the cost savings
The customer reciprocates.
In the office we have a whiteboard 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.
Few share them.
It's the sharing that makes the model so powerful.
The company grows by giving back.
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 to raise the probability of long term success.
When Costco continues to recycle cost savings to the consumer, it is lowering the probability
Of failure.
And before I read this next sentence to you, remember it is two thousand four when he is writing this. Amazon.com
may be following this path as well.
And so then he tries to reconcile it's like this business model makes sense to us. This is phenomenal if you're a customer.
But why are the shares mispriced? Why is this so cheap?
And so we list what some criticisms that Costco gets at the time.
The company has low margins.
And it's funny that he's mentioning both Costco and Amazon at this time'cause remember, one of B Jeff Bezos' most famous quotes is that your margin is my opportunity.
So the people are like, Well
We don't want to buy the stock because Costco has low margins.
And Nick Sleep says true, but that's the point.
The firm is deferring profits today in order to extend the life of the franchise.
And so as he continues to analyze Costco, he says there's an interesting question. What characteristics could one bestow on a company?
That would make it the most valuable in the world.
What would it look like?
And he says such a firm would have a huge marketplace that would offer size.
They would have high barriers to entry, which would offer longevity.
and very low levels of capital employed
Which would offer free cash flow.
Costco has some of these attributes.
It is also more asset light than its peers, but it's not the lightest of them all.
For that, one must turn to the internet.
I'm going to pause here before I read the next sentence, because I promise you you're not going to be able to guess what the next sentence is.
We just got gone through going through the the benefits of Costco.
They mention Amazon.
They mentioned they can only understand a few business models and this is one of them.
Costco is great, but imagine if you
Had Costco on the internet.
And given all that, we take this strange turn right here,'cause they said
Well, for that one, you gotta turn to the internet. So
And in our opinion, a business such as eBay
Could be the most valuable in the world.
So no, Costco is not perfect. Perhaps we should own eBay as well. No
I I wrote on the This is the next page. So you can uh read these for free online and I'd if you like reading physical things like I do, you can print them out. So I'm age fifty two.
On fifty one, on page fifty one.
They're talking about
you know, a uh the benefits of Costco, they talk that the fact that Michael Dell
is also using this model by keeping costs low and passing uh back scale benefits.
To the buyer of his PCs.
And that Amazon.com might be following this path as well.
On page fifty two.
It's like
Well, the cost could be great, but what if it was on the internet? So maybe it's eBay?
And I wrote in giant letters in the margin, the answer was on the previous page.
The answer is Amazon. They just don't know it yet. Now they will arrive at that. And I think that they're the the the most
The majority like that two billion dollars.
that they made. I think a b the the single company that contribute most to that, if I'm not mistaken, is Amazon.
And it is always helpful to think about what was going on when these words were written. So if you go, I went and looked up, like what didn't we
'Cause you read about early days of Amazon, you never read every single book I can find.
And for the longest time people thought that Bezos has no chance against eBay.
And think about this th in the end of two thousand four, the market cap
of Amazon when Nick Sleep is discovering this earned secret was nine was eighteen billion dollars.
eighteen billion.
The market cap
Uh in that same time for eBay was seventy seven billion.
In today's world we're living in, that sounds silly.
But if you go back to the early two thousands, it there was a ton of stuff written on the fact that
Amazon stands no chance against eBay.
And so on the next page he gives us his summary of thoughts on Costco.
In our judgment, Costco is a cost disciplined, intellectually honest, high product integrity.
Perpetual motion machine trading at a discount of value.
I think we will do quite well.
Your manager has already made his first mistake in investing in Costco.
From not buying enough.
Towards the end of his partnership letters, Nick Sleep writes something that's
Excellent. The fact that
Yeah, these ideas.
That work today.
They worked in the past, and they will build empires in the future, too. That is why I read 110,000 of these words. This is what I'm choosing to focus on as I speak to you.
The one the first thing that got me really interested in Nick's sleep is not his investment performance.
It's his observation that he lays out in the following quote. He says the best investors are
aren't investors at all.
They're entrepreneurs who never sold.
And since Nick is an investor, he's trying to learn from that. From learning that
Why these entrepreneurs not sell? He says the biggest mistake an investor can make
is to sell a stock that goes on
To rise tenfold.
Not from owning something into bankruptcy.
But that's what everyone thinks, at least judging by the questions that we get from our clients.
We got questions.
About our holding in Northwest Airlines rather than the sale of Apple earlier this year.
But selling Apple has cost us more.
So again, that speaks to Nick's own point about how difficult this was. When he's talking about that firm that sells IBM.
in the fifties and Walmart in the seventies, he's not like, Hey, look at these idiots, they're so stupid.
He's making the point that that mistake is repeated over and over and over again when you look through history. It's arrogant to think that you're not capable of making the same mistake.
So how do we avoid that?
And I think we'll talk about this later, but just in case I forget.
The idea that the best investors aren't investors
At all, they're entrepreneurs who never sold.
That has to do with the love that an entrepreneur feels for the business that they're making, that they're creating.
Sam Walton is not
Looking at his stock in Walmart.
and maximizing for the best return on the most dollars in his bank account.
He was focusing on building something great that served other people over a very long period of time.
In other words, sometimes it turns out that the best financial decision
is not a financial decision at all.
Now we get to two thousand six and they start to realize, oh my God.
It's not eBay.
Yeah.
Yeah, I should say that.
It's it's not evacuation.
It's Amazon.
I there's before he gets into analyzing Amazon though, I think he he hits on something that's very fascinating.
That it's related to the
It's it's on the page before he gets an Amazon, but I think it's related
to how he thinks about Amazon.
And he's like, you know, this is a really weird thing.
And the
Uh how we teach economics.
He says there's a blind spot.
as the overwhelming methodology m methodology for research and economics
has been to take observations over a short period time.
Аз каз і ефект.
sit on top of each other.
Remember the line for when we get to Jeff Bezos' own shareholder letters who are
who are who are quoted heavily.
And Nick Sleep's partnership letters, okay?
It's this really weird thing.
We're assuming that you know observations happen over a short period of time as if cause and effect sit on top of each other.
And really this all ties to his main point of why having a long longer view
A longer term view can be just a massive advantage. And he makes the point that both Costco and Amazon at this time they're penalized by the public markets because they're giving so much of their
scale efficiencies back to the consumer.
And so he goes, Okay, well how do we how should we think about this? How should he call them price get back.
Here's what Jeff Bezos.
says had to say in his last year's annual report.
We have made a decision to continuously and significantly lower prices for customers year after year as our efficiency and scale make it possible.
This is an example of a very important decision that cannot be made in a math based way.
When we lower prices we go against the math, which always says
That the smart move is to raise prices.
We have significant data related to price elasticity.
With fair accuracy, we can predict that a price reduction of a certain percentage will result in an increase in units sold of a certain percentage.
With rare exceptions.
The volume increase in the short term is never enough.
To pay for the price decrease.
However
Our quantitative understanding of elasticity is short term.
We can estimate
What a price reduction will do this week in this quarter.
But we cannot estimate the effect.
That consistently lowering prices
we'll have on our business over five or ten years. It's exactly what
Nick was saying on the other
The mistake that uh the academics and economics make.
They act like
Cause and effect sit on top of each other.
Jeff is saying, Yeah, okay, you can quantitatively understanding
what this price reduction will do this week or this quarter.
But you can't say
what effect it'll have over the business for five or ten years. This is why
One of my favorite lines about what
what the role of the founder actually is.
The founder is the guardian of the company's soul.
This is an example of that.
Our judgment.
is that relentlessly returning efficiency improvements to scale economies
to customers in the form of lower prices create a virtuous cycle
that leads over the long term to a much larger dollar amount of free cash flow.
And thereby
to a much more valuable Amazon.
We have made similar judgments around free super saver shipping and Amazon Prime.
both of which are expensive in the short term and we believe
important and valuable in the long term.
the timing in which Jeff is writing this and which Nick is commenting on it is really important.
This is a time when few people are buying Amazon.
Nick and Zach have their earned secret.
They are half a decade into their partnership.
And so Nick writes, This is a summary of the scale efficiency shared model that we dealt with in detail.
In our analysis of Costco years before.
And is deployed by companies which have now come to dominate nomad, which is his holding in Costco.
Dell.
Amazon and Berkshire.
If the share price is being set by those with an eye on the next data point.
then they can't also be looking out for the long term value.
There are few traders that disagree with Bezos value creation process.
But they don't think it'll show up in the numbers just yet.
The traders have many small ideas.
And we have one big idea.
Good luck to them.
It is not strictly a math based equation, and there's no guarantee that investment spending will always work.
And he quotes Bezos again.
Math based decisions command wide agreement.
Whereas judgment based decisions are rightly debated and often controversial.
At least until put into practice and demonstrated.
Any institution unwilling to endu controversy.
Must limit itself to decisions of the first type.
In our view, doing so
would not only limit controversy
It would also significantly limit innovation.
and long term value creation.
That is the end of Bezos' quote.
This is Nick's one word response. Amen.
And the next sentence he says, I think Bezos would run a good investment fund.
But that is the point.
Good investing and good business decisions are synonymous.
And so in one of the two thousand seven
partnership letters he talks about how and why Amazon can get even better.
Now keep in mind the following year he doesn't know this yet.
The following year, you're gonna be able to buy Amazon stock for like thirty five dollars. Okay.
So he's asking the question like how do we know that a business will actually grow from a mouse to an elephant?
And he identifies the same traits that in the physical world
That Costco has
And then it could be superpower by the internet. So, you know, several things are important. A business ought to be able to self fund its own growth.
Second, barriers to entry should increase with size.
That way the company's moat is widened as the firm grows.
And then the giant advantage that Amazon has over Costco.
Is that on the internet power law is very high.
And this implies that businesses like Amazon have a shot at being far bigger than
quicker and more profitable.
than their physical world equivalents.
And the fact that it's led by a customer centric founder.
This combination makes us think
That we may have a mouse that can turn into an elephant.
To those who argue that Amazon is large already, we ask you two questions. What do you think e-commerce will be as a proportion of US retailing
In ten years time.
And what do you think it was last year?
So the answer to that second question is
Three point one percent.
of all retail sales happened online in the year two thousand six.
And so then he goes back to this unresolved problem.
It's like everybody else is diversified.
That doesn't make a lot of sense to us.
How should we be thinking about this? This is very difficult.
And so since they had bought Amazon.
It went up twice.
So said after the doubling of the share price, it'd be easy for Zach and me to clay, high five, and sell our shares in Amazon.
In previous nomad letters, we have argued that the biggest error an investor can make is the sale of Walmart or Microsoft in the early stages of the company's growth.
We wonder would selling Amazon today

Mistake of selling Walmart in nineteen eighty.
And so he talks about let's invert let's invert the way to construct a portfolio.
The other way to construct a portfolio that's different from how other people do it is to invert and start at a hundred percent waiting and work down. This is what founders do.
He's really saying without saying, What if you invested like founders invest?
Right? A hundred percent.
Same old, hundred percent of his net worth.
Was in his company.
And he says, now we are not advocating all the fun in Amazon. Well, just not yet, at least.
And here's the crazy thing, that would have been their best performing decision.
Assuming you're gonna put all your money into what you've already invested in.
They didn't know it then, obviously, but they the best performance decision would have d to do just that.
Allocate the entire fund to Amazon.
And he tells a wonderful story why this is so difficult and this is hilarious.
He says it was recently reported
That oil had been found.
Not in the far flung reaches of the globe.
But under the headquarters of Exxon.
In Irving, Texas.
And not by Exxon.
Sometimes
What you are looking for is right in front of you.
If Exxon can make that mistake, we all can.
So now we're in the great financial crisis of two thousand eight.
Remember, Nick ta said the the greatest speech on investment wasn't about investment. It was about
There's a psychology of human misjudgment.
And he's talking about, you know, everybody's panicking, I think
they're gonna wind up being down like forty percent this year, forty five percent the uh at the at the end of the year.
And he says in the the the letters before this even happens, I think he's only down at twenty percent at the same time he goes. I know it doesn't seem like it, but I promise you this is the best possible time.
To be an investor.
And he's looking at the underlying strength of Amazon. It's completely uncorrelated to stock price, and he cannot believe it.
Th this next section goes over many, many pages. It's one of my favorite parts of his entire letters.
And so he's about to make the point using Amazon as an example that hey, customers respond incentives, like all people do.
And Amazon's sharing of these
benefits of its scale.
Will make them grow much farther from here.
And you can see it with how they're actually performing in the middle of this great financial crisis that's happening in two thousand eight.
And so he's comparing Amazon's strength with the lack of strength that normal retailers have. So he calls them high low. You know, people that say, Hey
You know, they they get you in the door by essentially d heavily discounting, having like a loss leader and in the hopes that once you're in the store you're going to buy something that they have a higher margin on. So he's gonna call them high street peers, okay?
Amazon's high street peers could price their products
at net income break even and still not undercut Amazon's prices or profitability.
For these high street competitors, the game is over. He's writing this in two thousand eight when everybody's panicking.
Nick is thinking very rationally and seeing things v unbelievably clearly.
They will leak revenues to more efficient rivals as customers respond to the incentives.
of consistently low prices and convenience.
Scale economics works well in bad economic times as well as good.
On the busiest day in the run up to Christmas this year in two thousand eight.
Order volumes at Amazon were sixteen percent higher than the previous year.

overall retail industry, which are down ten percent.
In the last few months, Amazon has been priced in the market as if it would not grow in the future.
Despite some of the best growth prospects we can imagine.
That is a very rare combination.
And there's a hilarious illustration of this point that he Nick's right, scale economics works well in bad economic times as well as good. This happened in two thousand eight.
back when there was a recession in the early nineteen nineties.
Sam Walton was asked about the recession that was happening and he said, I've thought about it and I've decided not to participate.
When you have order volumes at Amazon growing sixteen percent year over year in one of the worst financial crisis that the
In you know, half a century or whatever the the time frame was.
That's Jeff Bezos saying, Yeah, I thought about it, I'm not going to participate.
And so it's exactly when everybody's panicking when he's investing in Amazon. He says in our opinion, just a few things in life are noble.
And it is because just a few things are knowable, then Nobad has just a few investments.
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.
Sam Walton did not make his money through diversifying his holdings, nor did Bill Gates, Andrew Carnegie, or John D. Rockefeller, great businesses.
Are not built that way.
Indeed, the portfolios of these men were more or less one hundred percent in one company, and they did not consider it risky. Go back to that quote.
The best investors of all time are not investors at all.
They're entrepreneurs who never sold.
And so he's asking the question, why is it that no one
But the founding Walton family owned Walmart all the way through.
Zack and I were told a story which we enjoyed enormously.
And might help illustrate this point. In the ear nineteen seventies, a large successful fund management company analyzed its portfolio.
and discover that their sale of IBM thirty years earlier
had been a huge error of omission. If they had instead kept their IBM shares for the last thirty years, that stake alone would have been larger than the total funds under management.
They all agreed that
To learn from that particular mistake and as so often happens, went back to their desks and got on with life before as if nothing had happened.
Around the same time that they realized their mistake, they also made the decision to sell their stake in Walmart.
Which thirty years later would be worth more than their then to be funds under management in terms of dollars of opportunity loss.
is likely to be the biggest single error.
That firm will make
And so then he makes a point a few pages later, like you cannot just focus on the outputs.
If you do, you're gonna sell.
You have to really understand the central engine of success. You have to understand that.
business deeply.
This is why he says so few things can actually be known.
And if you can only know a few things well, then of course you need to be heavily concentrated and bet heavily.
It could be argued that lots of things had to go right for Walmart to grow for forty years.
That is certainly true, but at its heart, a very few simple things really mattered. In our opinion, the central engine of success at Walmart.
was a thrift orientation, so low cost.
No waste.
Fueling growth.
with the savings shared with the customer.
That is the deep reality of the business.
And so you could pause there if you're interested in investing.
You say, Okay, so who's doing this now?
Who today is the Walmart of the nineteen seventies, or you can ask yourself, okay, how do I apply this
to my own business, so my business, the one I'm running today.
Can compound for decades.
And he wraps this up beautifully because he's at they're asking essentially
The reason they're studying the Walmart and reason they did all the work on Costco is they're like is
Amazon or Walmart.
And I absolutely love this section because it's really comes to what you and I've been talking over the past few weeks.
Effort.
And opportunity costs.
Munger says that all wise people, the way wise people make decisions is through opportunity costs and then effort. So it says when Zach and I traw through the stock market these last eighteen months, we read a thousand annual reports and visited and interviewed three hundred companies.
We had four main choices. One, we can add to our existing holdings.
Two, we can invest in new businesses.
Three, we can invest in growth businesses, or four, we can invest in cigar butts.
Overwhelmingly, we have preferred our existing businesses to the alternatives.
We are not saying that Amazon is the next Walmart. Time will tell on this front.
But we are asking the question.
What if it is
And if the answer is yes, then the answer is on the next page. It talks about the investor self Clareman.
who wrote margin of safety, was once challenged on whether Buffett's track record was statistically significant.
Since he traded so little.
To which Claremont answered.
That each day Buffett chose not to do anything was a decision taken too.
When I read that, I assume that Nick is seeing himself in that story.
Right now in two thousand eight, he's like, I got Costco. I got Berkshire.
I got Amazon.
The key is to not mess that up. He 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'cause I think we're naturally wired to do something.
To take action.
And what made me want to spend time studying Nick, Sleep, and Zach and Lilu and Bezos and everybody else is because of this idea. Remember what Lelo said he was asked? He's just like, Well
How do you what how is your approach different than uh other investors that are less successful than you? He's like I I don't spend any time
Worrying about what uh other investors do.
I spent all my time studying great companies and studying great industries.
If Nick and Zach were worried about what other investors were doing at this time, they wouldn't be doing what they're doing. They wouldn't have been buying Amazon. They wouldn't have been talking about Costco.
And so there's this unnamed founder.
That
is running one of Nomad's investments that said this in a private meeting.
I'm I I this has gotta be Bezos. They don't say it's Bezos, but listen to this. And I think again
It let's let's just assume this is Bezos. Bezos is running his business this way.
I would argue that Lelu ran his businesses away.
And then Nick and Zach were running their business this way.
If you want to be successful and we do.
then you have to be willing to be misunderstood. Okay. Come on. This has been a main theme the last month.
And do things that
Do not seem sensible to most people.
For example, if you, the employees, come into the office in the morning thinking how are you gonna beat number one, number two, and number three in the industry?
Then our business is the wrong place for you.
We start with the customer and work backwards.
He continued.
That rather than set your standards by what others do
The business benefit from a divine discontent with the status quo.
Which kept us on our toes and the business improving.
Irrespective
of what the competition was doing.
In other words, his company had an internal compass.
With true north pointing to what was right for the customer.
Sounds a lot like what Jim Sinegal did at the beginning, he was like
Hey, supplier's like, hey, we got such a good deal on these designer jeans, we can mark them up, you know, another another ten dollars, no one will notice.
And he's like, No.
I'm not gonna do that because that violates my internal compass, which
My which points to always doing what's right for the customer.
And Jim Sinegal's thinking on this was heavily
Heavily influenced by his mentor Sol Price.
I've done two episodes on Sold Price, if you haven't listened to them yet, it's episode three oh four.
Soul Price, the founder who taught Jim Sinegal, Sam Walton, Jeff Bezos, Bernie Marcus.
It's based on a biography written by his son.
His son listened to that episode.
And sent me a very, very kind email.
So Zach and Jim or Z uh Nick and Zach, rather.
Are meeting with Jim.
And he says, uh Jim suddenly stopped in mid sentence, his face lit up. I must show you this, he said.
And he disappeared into a filing cabinet. He emerged with a memo from nineteen sixty seven.
written by Soul Price.
And he gave them a copy. They framed it and hung it on the office wall. The memo says this, this is sole price.
This is what Jim thought was super important.
Although we are all interested in margin, it must never be done at the expense of our philosophy.
Margin must be obtained by better buying, emphasis on selling the right kinds of goods we want to sell.
operating efficiencies, lower mark markdowns, greater turnover.
Increasing the retail prices and justifying it on the basis that we are still competitive.
Could lead to a rude awakening.
As it has with so many.
Летис концентра
We can bring things to the people.
Rather than how much traffic how much the traffic will bear.
And when the race is over
Fedmart will be there.
This is Nick's commentary. The b that is the best summary of the business case for scale economics shared that we have come across.
Forty three years later.
Costco is the most valuable retailer.
of its type in the world.
Cultures that care about the little things all the time are very hard to create.
And in the opinion of
Jeff Bezos almost impossible to create
If not
Put in place
At the firm's genesis.
And then I want to end on what I think is the main point and the main idea behind this episode that these ideas
are timeless and are transferable to our work.
When we study truly great businesses, we find that very often it has been simple human attributes.
That have led to their success.
You feel differently drinking a Coke.
than a no brand cola.
Or you may feel differently towards a business that consistently undercuts the competition in price.
or a deliverice that literally goes the extra mile and picks up return items.
And the reason you have these feelings
And the stimuli that produce them
have hardly changed in millennia.
It is interesting to note that the business model that built the Ford Empire a hundred years ago
Is the same.
that built Sam Waltons in the nineteen seventies.
Herb Kelleher's in the nineteen nineties are Jeff Bezos's today.
And it will build empires in the future.
Two
And that is where I'll leave it for the full story. Highly recommend reading the shareholder letters, all of them. They're available for free.
on Mixed Charity website I will
Leave a link down below and then
If you don't wanna read all two hundred and eighteen, two hundred and nineteen pages of the showholders
I would heavily recommend buying William Green's book, the one I covered, uh that did the chapter last week on Nick and Zach.
The book is called Richer, Wiser, Happier, How the World's Greatest Investors Win in Markets and Life. The author William Green listened to the episode and he loved it.
A bunch of my friends have bought that book this week.
I will leave a link down below. If you buy the book using that link, it'll be supporting the podcast at the same time. That is three hundred and sixty-five books down.
One thousand ago.
And I'll talk to you again soon.
When I was reading these letters and it was very clear that Jim Sinegal and Costco's obsession
was this total commitment.
To this everyday low price strategy that they had. Everything they were doing was serving that one goal.
And when you read that or when you listen to that, you start to think, okay, what is my organization's goal? And so my goal, my one goal, the central organizing principle of
My entire life's work.
is that I want to help other people learn from history squeeze entrepreneurs and I wanna do that better than anybody else in the world.
And so as a byproduct of making this podcast to in order to make the podcast.
I have to collect and distill the knowledge, the collective knowledge of history's greatest entrepreneurs.
And then I use the podcast to spread that knowledge far and wide because
I really do think these biographies, these shareholder letters, these autobiographies
I really do think
It is an act of service that
Other people can benefit from a, you know, four, five, six decade long career.
And so this obsession takes form of a podcast, but now I've made a tool
to make sure that I never forget the lessons and that I can pull them up on demand when I need them. And that tools founders notes, which you can now get access to that tool as well.
Founders notes let you tap into the collective knowledge of history's greatest entrepreneurs on demand. And it's a very simple way because for the last six years,
I've been putting all of my notes and highlights for everything that I read for the podcast.
into a giant searchable database.
That you can now tap into.
And even if you didn't know about this tool
You hear me use it over and over again because every time you listen to the podcast and I'm referencing past ideas from past episodes, from past books.
Like when I brought up Jeff Bezos or when I was talking about Walt Disney in this episode.
Or Sam Walton or Munger or Buffett or all of this. That is me searching through founders' notes and pulling up those ideas.
And that is a really important point to get across. What you see, if you subscribe to Founders Notes.
That is the same tool that I use. You see the exact same thing that I use.
It is a tool that I made for myself and I had for years.
Before I even thought about making it a tool that other people can get access to.
Existing subscribers to founders notes have been using it to help them think through issues they're having from anything in their company from hiring to recruiting to marketing to leadership to preparing for board meetings.
They're preparing sales presentations.
If you are already running a successful company, I think it's a no-brainer to invest in this tool.
You can tap into the collective knowledge of Hish Gaze founders on demand.
by going to founders notes dot com. That is founders with an S, just like the podcast.
Founders notes dot com
And subscribing today.
Thanks for support. Thanks for listening, and I'll talk to you again soon.