Learnings from Nomad Investment Partnership Shareholder Letters
It is always advisable to study shareholder letters of those successful investors who have proven themselves through their investment style.
It is always advisable to study shareholder letters of those successful investors who have proven themselves through their investment style.
Some of the very famous shareholder letters are Buffet partnership and Berkshire Hathaway shareholder letters, Amazon shareholder letters, Constellation Software letters, Nomad Investment Partnership letters, Terry Smith shareholder letters, and so on.
I'll share some of my learnings from Nomad Investment Partnership letters in this content. Nick Sleep and Qais Zakaria were the founders of this investment firm. Their funds delivered around 921% since inception starting from Sept 2001 and grew at 20.8% CAGR before performance fee whereas MSCI World Index gave only 117% at 6.5% CAGR. That means $1 would be around $10 by the time they shut down their firm.
The letters are full of wisdom. One prominent term, “Shared Economy Shared” appears very frequently. Their popular bets on Amazon and Costco are worth studying. Let's go through some of the wisdom the letters have in store for us.
Philosophy of Their Investment
Their philosophy of investing -
"We are looking for businesses trading around half of their real business value, companies run by owner oriented management and employing capital allocation strategies consistent with long term shareholder wealth creation."
To elaborate this, they reiterated their philosophy again in Dec 2003.
"Aim is to make investments at prices we consider to be 50 c on the dollar of what a typical firm is worth. Capital allocation must be consistent by investee companies with value creation."
You see how many times valuation word comes.
Their investment is classified into 5 major points.
1. Scale economies shared
2. Discounts to replacement
3. Cost with pricing power
4. Hated agencies
5. Super high quality thinkers
3/4th of investment is into growth oriented business and 1/4th is into cigar butts.
Sleep readily mentioned their mistake in Dec 2003 letter.
"Our most common mistake is to misjudge capital allocation decisions by our companies - firms which articulate a share repurchase/debt repayment strategy, or have incentives to reinforce that outcome throw caution to the wind and make acquisitions instead."
Sleep has discussed a lot of stocks and their theses of investment at various times. Some of them are International Speedway, Matichon, Xerox Corporation, Costco Wholesale, Monsanto company, Stagecoach, Weetabix, Amazon, Lucent, Air Asia, Games Workshop, Black Arrow amd and so many. This is why it is extremely important to study shareholder letters to understand the thesis behind an investment.
Let's discuss the thesis behind Costco purchase.
“Costco is profitable enough to self-fund growth of around 14% per annum and not to have to resort to leases for expansion. This means that growth will be more measured. and should be more sustainable. As to the potential for growth the firm has 21 stores in Washington State which houses just 2% of the US population. This density coast to coast implies room for around 1,000 US stores (currently 284) and 200 stores in the UK (currently 14) although planning regulations may not allow for this. Even then Home Depot, the largest DIY store in the US currently has 1,500 stores. At 10% growth per annum, this implies the firm has another 13 years of growth ahead. The share price has declined from a year 2000 high of $55 to $30 as margins declined slightly with the cost of several new distribution centers which will support the next few year’s growth. For example, in the UK the firm has warehousing and logistics capacity for 40 locations but only has 14 stores. At $30 the firm is valued as a cash cow, with higher levels of profitability (as capacity utilization increases) and modest levels of growth justifying a valuation over $50 per share. Costco is as perfect a growth stock as we have analyzed and is available in the stock market at a close to half price."
Sharing Costco investment reasons, Sleep also explained why Costco was mispriced.
“Heuristic One: “the company has low margins” (net profit margin is 1.7%, compared to Wal Mart at 3.6% and Target at 4.2%). True, but that’s the point. The firm is deferring profits today in order to extend the life of the franchise. Of course, Wall Street would love profits today but that’s just Wall Street’s obsession with short term outcomes. Heuristic Two: “it’s expensive at 24x earnings”. Really? Net income is a small residual, as discussed above. The firm could earn Wal-Mart margins by taking pricing up a little, in which case the firm would be on 11x earnings, but would it be a better business as a result? We think not, if it allowed the competition to catch up. Heuristic Three: “Costco has a cost problem”. Costs have risen as a percentage of revenues in the last few years due to the expense of a warehouse and distribution system associated with the next phase of the firm’s growth and the cost of employee benefits and insurance, especially in California. This has people fooled who really should not be.”
His robustness ratio is a framework to help you think about the size of the moat around a company. For ex, Costco. The company retains 1 dollar and customer saves 5 dollars. This is the amount of money a customer saves compared to the amount earned by a shareholder. A Costco cardholder saves somewhere in the region of $175/yr by shopipng at Costco in return for an annual fee investment of $23. That means a net gain of around $150/ yr for every cardholder. Hope you understand the scale economy shared concept well.
Let's understand what the Scale economy shared is. It means when the business grows in size, savings are given back to the customers in the form of lower prices. The customers then reciprocates by purchasing more goods which provides greater scale for the retailer who passses on the new savings as well. This is why firms such as Costco enjoy sales per foot of retailing space four times greater than run-of-the-mill supermarkets. Scale economics shared incentivises customer reciprocation, and customer reciprocation is a super-factor in business performance. Costco has this power. As they are scaling, they are savings their customers' pockets as well. In shared economy, you share the benefits with your customers along with scaling your business.
Sleep gave an interesting comparison between K Mart/Wall Mart and value investor/growth investor.
Value investors = K Mart = Cheap (stock measured by price to book but a dreadful investment measured by performance)
Growth investors = Wall Mart = Expensive
"Difference should be like this. It lies in analysing not the effects and outputs of a business but digging down into the underlying reality of a company; the engine of its success. One must see an investment not as a static balance sheet but as an evolving compounding machine."
In June 2005, Sleep introduced Bill Miller's speech on competitive advantages. There are 3 kinds of it. One is informational ( I know a meaningful fact nobody else does), analytical ( I have cut up the public information to arrive at a superior conclusion), and psychological (Behavioural).
Some Quotes
"Good investing and good business decisions are synonymous." Because investment is also a business where you are constantly finding a good capital allocation situation.
"If one is to be a successful long term investor, she/he needs to recognize the sources of enduring business success, get in early and own enough to make a difference." Ultimately you have to identify how scalable and sustainable the business is going to be in future, get in early with heavy position. So, basically he talks about long term vision, position sizing, and courage.
"Understanding the value of a business involves assessing the likely outcome given management behaviour and competitive forces and weighing the probable outcome in a valuation. So, an inability to arrange in probabilities is a considerable error causing bias in investors' decision making process and is behind many mis-valuation."
"An interlocking, self-reinforcing network of small actions may be more successful than one big thing."
"Share prices are an aggregate of all possible future worlds, not the actual future. "
Same happened with his investment into Amazon. Stock price just started to go up, business was doing well, opportunity size was huge, industry tailwinds were just growing, strong moat around the company, scale economy shared existence, owner-oriented management, everything made him to invest.
Let me include an interesting mathematical calculation on how to concentrate portfolio given in their letter.
According to J. L Kelly, the formula is 2.1*p-1.1
If someone is 75% certain of being right, the correct weighting remains high at 47.5% = [(2.1*0.75) -1. 1], p = probability of being right
Thanks for reading
Take care
Rabi
Disclaimer: I'm not SEBI registered. This content is for educational purposes only. Do your own diligence.