Letter #08 Dec’2007
The theme of this letter is mistakes.
1.It is seen that investors are unforgiving when a company disappoints them. Investors presume that companies do not learn from their mistakes, and this makes sense as many organizations struggle with rational behavior.
But the model followed by Nomad’s is to learn from the mistakes and this is practiced by as they invest in the business that have made mistakes. (Examples, Dell, Sony, Ford etc)
“For these investments to work over the long haul, what is required is a rational, honest mea-culpa and a low share price. The unforgiving nature of the markets often provides the latter. The former is much harder to come by.”
2.Companies often misclassify their mistakes in terms of outputs rather than inputs, and in so doing allow the original mistake to go unchecked.
3.The mistake is only a mistake if you call it so otherwise it is a learning opportunity. In the letter, Nick sleep has stated the examples of 2 companies in which they committed mistakes. One is Conseco which went bankrupt.
“Conseco went bankrupt after losses in its manufactured housing loan securitization trusts impaired capital at its insurance company and A.M. Best, the insurance industry rating agency, declared the business inadequately capitalized. Our analytical mistakes were multifarious, but the most serious was to anchor on analysis at the time of purchase to justify continued holding. The immediate dollar loss was around U$5m for investors in Nomad. However, the opportunity cost loss, the dollar loss adjusted for subsequent Nomad performance (a fairer reflection of real costs) is around U$10m.”
The second was stagecoach where they purchased shares at a lower price but sold too early.
"The analytical mistake in both cases was to have a static view of a firm formed at the time of purchase, which failed to evolve as the facts changed. This error was reinforced by misjudgments such as denial (the facts had changed) and ego (we can’t be wrong). There was also an over-reliance on price to value ratio type analysis, which can encourage a tighter range of outcomes than occurs in reality.
And what did we learn in Investing 101 from Lord Keynes:
“Better to be generally right than precisely wrong”! At the time we were making these errors we would have held Keynes’ quote as true. One has to be so careful; sometimes these mistakes are very insidious. Keynes’ dying words were reported to be “I should have had more champagne”. No doubt he is right on both accounts"
- Three mistakes that contribute to more unhappy outcomes than most.
1)Denial, that is the reinvention of reality in the mind because the truth is too painful to bear.
-
Anchoring: A static, historic vision of a problem; and drift, that is how small, incremental changes in thinking build into a big mistake.
-
Judging: Speaking very high of an idea that’s a lot of rational thoughts.
- Is it necessary to speak about your investments? It is interesting to note that the two of the best performing funds did not disclose all of their holdings at some point of time. This were the Buffett partnership and Walter Schloss Associates. Although Buffett wrote extensively about how he thought and approached investing in general. And it was for a good reason that they did not disclose their holdings, they did not wish to be judged, second-guessed or worse.
"When we think of our investee companies, the firms which we would quite happily own with no word from them for years are those businesses in which we have the highest confidence of reaching a favorable destination: they are the firms we think we know will work. They are also the largest holdings in Nomad. It is the less certain businesses about which we are more insecure that appear to demand more regular attention. "
6.Always focus on what you can control.
“In our opinion, the biggest risk in investing is the risk of misanalysis. We seek to control this risk through the quality of our research, especially through applying what we have learnt. The quality of our research-based decisions overwhelmingly determines whether we will do well in the long run. But it has almost no influence over the timing of these results. Zak and I do not control the annual performance figures. It might be nice if we did. But we don’t.”