A letter a day!

Knowledge Series
102

A letter a day!

Letter 74 #2020

Key learnings:

  1. Berkshire’s investment in Apple vividly illustrates the power of repurchases.

It started purchasing apple late in 2016 and by july 2018 owned slightly more than a billon shares. It finished its purchases by mid 2018,Berkshire’s general account owned 5.2% of Apple.

“Our cost for that stake was $36 billion. Since then, we have both enjoyed regular dividends, averaging about $775 million annually, and have also – in 2020 – pocketed an additional $11 billion by selling a small portion of our position. Despite that sale – voila! – Berkshire now owns 5.4% of Apple. That increase was costless to us, coming about because Apple has continuously repurchased its shares, thereby substantially shrinking the number it now has outstanding. But that’s far from all of the good news. Because we also repurchased Berkshire shares during the 21⁄2 years, you now indirectly own a full 10% more of Apple’s assets and future earnings than you did in July 2018.”

  1. Story of Buffett’s early years : How he started!

"Before my Berkshire years, I managed money for many individuals through a series of partnerships, the first three of those formed in 1956. As time passed, the use of multiple entities became unwieldy and, in 1962, we amalgamated 12 partnerships into a single unit, Buffett Partnership Ltd. (“BPL”).
By that year, virtually all of my own money, and that of my wife as well, had become invested alongside the funds of my many limited partners. I received no salary or fees. Instead, as the general partner, I was compensated by my limited partners only after they secured returns above an annual threshold of 6%. If returns failed to meet that level, the shortfall was to be carried forward against my share of future profits. (Fortunately, that never happened: Partnership returns always exceeded the 6% “bogey.”) As the years went by, a large part of the resources of my parents, siblings, aunts, uncles, cousins and in-laws became invested in the partnership.

Charlie formed his partnership in 1962 and operated much as I did. Neither of us had any institutional investors, and very few of our partners were financially sophisticated. The people who joined our ventures simply trusted us to treat their money as we treated our own. These individuals – either intuitively or by relying on the advice of friends – correctly concluded that Charlie and I had an extreme aversion to permanent loss of capital and that we would not have accepted their money unless we expected to do reasonably well with it.
I stumbled into business management after BPL acquired control of Berkshire in 1965. Later still, in 1969, we decided to dissolve BPL. After yearend, the partnership distributed, pro-rata, all of its cash along with three stocks,
the largest by value being BPL’s 70.5% interest in Berkshire. Charlie, meanwhile, wound up his operation in 1977. Among the assets he distributed to partners was a major interest in Blue Chip Stamps, a company his partnership, Berkshire and I jointly controlled. Blue Chip was also among the three stocks my partnership had distributed upon its dissolution. In 1983, Berkshire and Blue Chip merged, thereby expanding Berkshire’s base of registered shareholders. from 1,900 to 2,900. Charlie and I wanted everyone – old, new and prospective shareholders – to be on the same page. Therefore, the 1983 annual report – up front – laid out Berkshire’s “major business principles.” The first principle began: “Although our form is corporate, our attitude is partnership.” That defined our relationship in 1983; it defines it today. Charlie and I – and our directors as well – believe this dictum will serve Berkshire well for many decades to come."

  1. In 1958, Phil Fisher wrote a superb book on investing. In it, he analogized running a public company to managing a restaurant. If you are seeking diners, he said, you can attract a clientele and prosper featuring either hamburgers served with a Coke or a French cuisine accompanied by exotic wines. But you must not, Fisher warned, capriciously switch from one to the other: Your message to potential customers must be consistent with what they will find upon entering your premises.

“At Berkshire, we have been serving hamburgers and Coke for 56 years. We cherish the clientele this fare has attracted.”

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A letter a day!

Letter # 75 2021

Key learnings:

  1. Many people perceive Berkshire as a large and somewhat strange collection of financial assets. In truth, Berkshire owns and operates more U.S. based “infrastructure” assets classified on their balance sheet as property, plant and equipment than are owned and operated by any other American corporation.

“That supremacy has never been our goal. It has, however, become a fact.”

  1. Buffet has talked and time and again praised Ajit Jain who looks after the insurance portfolio of Berkshire. He hired Ajit when he had no experience at all relating to insurance.

"Much of our huge value creation in insurance is attributable to Berkshire’s good luck in my 1986 hiring of Ajit Jain. We first met on a Saturday morning, and I quickly asked Ajit what his insurance experience had been. He replied, “None.” I said, “Nobody’s perfect,” and hired him. That was my lucky day: Ajit actually was as perfect a choice as could have been made. Better yet, he continues to be – 35 years later."

  1. Buffett is known to teach and interact with a lot of university and school students. He advices them never to stop their quest even when they actually find a job.

“Talking to university students is far superior. I have urged that they seek employment in (1) the field and (2) with the kind of people they would select, if they had no need for money. Economic realities, I acknowledge, may interfere with that kind of search. Even so, I urge the students never to give up the quest, for when they find that sort of job, they will no longer be “working.” Charlie and I, our selves, followed that liberating course after a few early stumbles. We both started as part timers at my grandfather’s grocery store, Charlie in 1940 and I in 1942. We were each assigned boring tasks and paid little, definitely not what we had in mind. Charlie later took up law, and I tried selling securities. Job satisfaction continued to elude us. Finally, at Berkshire, we found what we love to do. With very few exceptions, we have now “worked” for many decades with people whom we like and trust. It’s a joy in life to join with managers such as Paul Andrews or the Berkshire families I told you about last year. In our home office, we employ decent and talented people – no jerks. Turnover averages, perhaps, one person per year”

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A letter a day!

Letter #76 2022

  1. When large enterprises are being managed, both trust and rules are essential. Berkshire emphasizes the former to an unusual some would say extreme degree.

“Disappointments are inevitable. We are understanding about business mistakes; our tolerance for personal misconduct is zero.”

2.Capitalism has two sides: The system creates an ever-growing pile of losers while concurrently delivering a gusher of improved goods and services. Schumpeter called this phenomenon “creative destruction".

3.Controlled businesses are a different breed. They sometimes command ridiculously higher prices than justified but are almost never available at bargain valuations.

4.One advantage of publicly traded segment is that it becomes easy to buy pieces of wonderful businesses at wonderful prices. It’s crucial to understand that stocks often trade at truly foolish prices, both high and low. “Efficient” markets exist only in textbooks.

5.The lesson for investors: The weeds wither away in significance as the flowers bloom. Over time, it takes just a few winners to work wonders. And, yes, it helps to start early and live into your 90s as well.

6.When the share count goes down (Buyback happens), your interest in our many businesses goes up. Every small bit helps if repurchases are made at value-accretive prices. Just as surely, when a company overpays for repurchases, the continuing shareholders lose.

  1. Buffett has written down few of the thoughts of Charlie Munger from one his podcast:

•The world is full of foolish gamblers, and they will not do as well as the patient investor.
• If you don’t see the world the way it is, it’s like judging something through a distorted lens.
• All I want to know is where I’m going to die, so I’ll never go there. And a related thought: Early on, write your desired obituary – and then behave accordingly.
• If you don’t care whether you are rational or not, you won’t work on it. Then you will stay irrational and get lousy results.
• Patience can be learned. Having a long attention span and the ability to concentrate on one thing for a long time is a huge advantage.
• You can learn a lot from dead people. Read of the deceased you admire and detest.
• Don’t bail away in a sinking boat if you can swim to one that is seaworthy.
• A great company keeps working after you are not; a mediocre company won’t do that.
• Warren and I don’t focus on the froth of the market. We seek out good long-term
investments and stubbornly hold them for a long time.
• Ben Graham said, “Day to day, the stock market is a voting machine; in the long term it’s a weighing machine.” If you keep making something more valuable, then some wise person is going to notice it and start buying.
• There is no such thing as a 100% sure thing when investing. Thus, the use of leverage is dangerous. A string of wonderful numbers times zero will always equal zero. Don’t count on getting rich twice.
• You don’t, however, need to own a lot of things in order to get rich.
• You have to keep learning if you want to become a great investor. When the world changes, you must change.

Warren and I hated railroad stocks for decades, but the world changed and finally the country had four huge railroads of vital importance to the American economy. We were slow to recognize the change, but better late than never.

• Finally, I will add two short sentences by Charlie that have been his decision-clinchers for decades: “Warren, think more about it. You’re smart and I’m right.”

And so it goes. I never have a phone call with Charlie without learning something. And, while he makes me think, he also makes me laugh. I will add to Charlie’s list a rule of my own: Find a very smart high-grade partner preferably slightly older than you and then listen very carefully to what he says.

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That’s a wrap for the letters from Buffett. I intend to continue this activity. Who wouldn’t want to learn from the greatest of the minds out there? If you have any suggestions about, what can I read next, please do let me know!

I shall resume this again once I have figured it out.

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You can read Howard Marks both books…

  1. most important thing
  2. Mastering mRket cycles
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That was a nice series, thanks for this effort! Since you have asked for suggestions, I suggest you take a look at ‘University of Berkshire Hathaway’ by Daniel Pecaut & Corey Wrenn. The book is a summary of Q & A sessions of Berkshire Hathaway’s AGMs from 1986 to 2016. The book gives an excellent insight into the thought process of Buffet & Munger and has several good quotes, which to the best of my knowledge have not appeared elsewhere. There is a lot of humor too, making the book easy and fun to read. For any avid follower of WB & CM, the book nicely complements the insights from his shareholder letters.

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Thank you. All words are wise.

Cheers
Ashutosh Sharma

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Thank you so much for your efforts. This is very valuable

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@aashka_trivedi Would request you to continue with the letters of other similar investors letters like

Nick and Zak’s Adventures in Capitalism: Words of Wisdom from the Nomad Partnership Letters

Howard Marks memos

and the likes

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Resuming “A letter a day” series with letter from Nick sleep and Qais Zakria who started Nomads investment partnership from 2001 to 2014.

Nick sleep is rather unknown yet successful investor. He has beaten the S&P500 over 14 years, achieving a whopping 20.8% compounded return from 2001 to 2014. He may not be a household name, but his performance as co-founder and CEO of his investment firm, Nomad Investment Partnership, has been nothing short of remarkable.

A book has also been published on the same by the title " Nick and Zak’s adventure in capitalism". For those who have kindle subscription, it is available for free. I will start posting from tomorrow. Looking forward to lots of learning ahead.

Cheers and happy reading!

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Hi @aashka_trivedi
Thank you for taking the lead to post Nick Sleep letters
Both Nick and Zack have cracked the Amazon puzzle and were one of the early investors of Amazon and still holds.
More than the learning it is an experience we get to read on how to invest and beyond.
For those who wants to know who both of them are
please read this book available on amazon.

https://www.amazon.in/Richer-Wiser-Happier-Greatest-Investors/dp/1501164856

Please post Buffett’s letter to Nick, on closing the Nomad partnership.

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A letter a day!

Letter #01 2002

Introductory letter

The Nomad Investment Partnership was launched in early September 2001 and began investing on September 10th.

1)While evaluating the potential of a business, look for the following 3 things:

1.Businesses trading at around half of their real business value.
2.Companies run by owner-oriented management and
3.Employing capital allocation strategies consistent with long term shareholder wealth creation.

(Finding all the three is rare)

2)They have discussed 2 investments in this letter

  1. International speedway (Approx 3.7% of the portfolio) :
    The narrative to invest was the money made through the race is divided 10% to NASCAR (The National Association for Stock Car Auto Racing) Matichon (3.2% of fund at year end) is Thailand’s second Thai language newspaper, 65% for the maintenance of the track and 25% is the price money. In the track maintenance segment, international speedway had the lion share.

  2. Matichon (3.2% of fund at year end) :Thailand’s second Thai language newspaper.

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A letter a day!

Letter #02 2002

Interim report #June 2002

  1. The Partnership has been invested in twenty-one companies in seven countries (Dominated by USA , followed by Hong Kong and Thailand). It had notable concentration in relatively few sectors: media and publishing; leisure, entertainment and casinos; and hotels and real estate. Smaller investments were made in telecoms and cable; consumer durables and finance; and computer services and office automation.

  2. In the letter a beautiful advice is shared from the book “Where are the customer Yachts?”

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

The operative phrase here is “pay no attention”. This is not easily done. Many investors are professionally required to “pay attention” to the latest trend for fear of missing out (pay attention and be invested!)

3.The investment time frames are very compressed, and few investors it seems don’t bother to assess the real value of a business but instead respond to the latest data point to determine share price direction. This is momentum investing and is the mechanism by which expensive shares become very expensive, just as cheap shares may become very cheap.

4.The partnership sold xerox corporation (Monsato company)

As per Nick sleep, the company showed decent profits despite of no visible growth in the revenue. On the other side management guided revenue growth of 15% when the current growth was around 5%. In order to achieve this guidance, management tried to push too hard to grow the earnings and started booking profits on long term lease contracts.

Annual performance #Dec 2002

1.The Partnership results had been achieved without leverage, shorting or financial derivatives of any kind, nor did they wish to employ such techniques.
Rather results have been achieved the old-fashioned way, through buying securities in reasonable businesses at discounted prices.

2.In analyzing a company, assess the merits of investing in all levels of the capital structure but to date it has been concluded that the common and preferred shares have been the more attractive investments.

3.One of Nomad’s key competitive advantages was the aggregate patience of its investors.

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A letter a day!

Letter #03 2003

Key learnings:

1.The partnership started investing in unlisted space from this year. The first investment being ,Weetabix Limited, a manufacturer of cereals and Bars in U.K.

2.The course of the market will determine, to a great degree, when we will be right (the sequence of annual outcomes), but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on what should happen rather than when it may occur.

3.Quality of managerial character is important to avoid capital misallocation.

4.Value creation is often most sustainable when it is built slowly.

5.As investors, winners flatter our ego regardless of the reason they went up, whilst we all feel bad about the losers.

6.Some principles applied in managing nomad partnership:

1)The reason, of which the firm is certain of the performance, is the decline in the level of fear felt by other investors.

2)The aim is to make investments at prices that is fifty cents on the dollar of what a typical firm is worth.

“Capital allocation by investee companies must be consistent with value creation and, if this is the case, we expect that the real value of the business (the 100 cents value) could grow at around 10% per annum. The effect over five years will be to compound U$1 of value into U$1.62, and companies that can build value like this are normally rewarded in the market with a fair valuation (i.e., are priced close to U$1.62). This happy outcome would imply a return from purchase price (50 cents) of around 26% per annum”

3)The most common mistake is to misjudge capital allocation decisions by the companies: firms which articulate a share repurchase/debt repayment strategy and have incentives to reinforce that outcome, throw caution to the wind and make acquisitions instead.

“The Partnership’s investment in Readers Digest falls into this category. Capital allocation mistakes such as these often prevent the compounding of value but to date have rarely resulted in a permanent decline in the share price to below our purchase price (50 cents). We have therefore tended to find that our mistakes atrophy (stay cheap) rather than collapse, although we can all name one collapse!”

4)The prime determinants of outcome are price (sticking to 50 cents on the dollar) and capital allocation by management. The first is in our control, that is, it is in our control to be patient and wait for the right price. The second involves a subjective judgment about the quality of management, and an assessment about the sustainability of business returns in the long run.

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A letter a day!

Letter #04 2004

1.As the cash is invested, portfolio concentration will rise.

“The logical extension of this line of thought is that Nomad’s portfolio concentration has at times been too low. And if it has been too low at Nomad, what has been going on at the large mutual fund complexes with many hundred stocks in a single country portfolio? Apply the Kelly criterion, and the average fund manager would appear to have almost no clue as to the likely success of any one idea. In our opinion, the massive over diversification that is commonplace in the industry has more to do with marketing, making the clients feel comfortable, and the smoothing of results than it does with investment excellence. At Nomad we would rather results were more volatile year to year but maximized our rolling five-year outcome.”

2.The more stocks you own the less you care about each one individually. Attention paid to corporate governance, capital allocation, incentive compensation, accounting, and strategy has to be diluted as the number of stocks rises.

“When over- diversification becomes the industry norm then in aggregate investors risk failing to police bad corporate behavior. Would fund managers be so liberal with dysfunctional management if the holding was 20% of the portfolio rather than 0.2%? Ofcourse not. Perhaps some of the scandals of the last few years would have been averted if fund managers had been more proprietorial about their holdings.”

  1. There are only two reasons companies behave well. Because they want to, and because they have to. Your preference should be to invest in those that want to.

4.Nomad partnership limited, at their office kept a list of companies under the title " Super high-quality thinkers" This list consisted of 15 businesses which according to nomad partnership was the compounding machines. However, this companies were not the same as Nomad’s portfolio. The reason is price.

"In paying up for excellent businesses today, investors are already paying for many years growth to come, in the hope that, as the saying goes, “time is the friend of a good business”.

5.On growth Vs Value

"We won’t end the debate here but, so that we all understand, our definition is that a business is worth the free cash flow that it can be expected to generate between now and judgment day, discounted back at a reasonable rate. Period. Growth is therefore inherently part of the value judgment, not a separate discipline. "

6.There is no reason why business values and share prices should move hand in glove. You should expect that there will be a time when prices, and your performance, significantly lags the performance of our underlying businesses. It is then when you should be contrarian and invest more.

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A letter a day!

Letter #05 2005

1.It is a constant feature of the investment landscape that people applaud recent gains when they should be thinking more about the future.

2.Following what everyone else is doing may be hard to resist, but it is also unlikely to be associated with good investment results.

3.What is your competitive advantage in investing?

There are three competitive advantages in investing:

1)Informational (I know a meaningful fact nobody else does);
2)Analytical (I have cut up the public information to arrive at a superior conclusion) and
3)Psychological (that is to say, behavioral).

“Sustainable competitive advantages are usually a product of analytical and or psychological factors, and the overwhelming advantage with regard to Nomad is the patience of the investor base and the alignment of that disposition with the analytical and psychological traits of your manager. It simply would not work otherwise. In the investment objective section of the Nomad prospectus, we say that our job is to “pass custody [of your investment] over at the right price and to the right people” and that “the approach will require patience”. That’s what investing is, at least for us.”

4.What you are trying to do as an investor is exploit the fact that fewer things will happen than can happen.

5.Robustness ratio: The robustness ratio is a framework we use to help think about the size of the moat around a company. It is the amount of money a customer saves compared to the amount earned by shareholders. This ratio is more appropriate for some companies than others, the prime criteria being that the customer proposition is based on price.

“In the Berkshire Hathaway annual report this year, the Chairman tells us that Geico policyholders saved U$1bn on their policies compared to the next cheapest carrier. It also turns out that Geico earned around U$1bn as well. So that’s one dollar saving to the customers and one dollar retained for shareholders.”

6.As a fund manager, always focus on the performance of the fund rather than the fund size.

Several hundred million dollars could have been invested in each of Costco (US), New World Developments (Hong Kong), Amazon.com (US), Telewest (UK) and Liberty Media (Europe and Japan). But as each idea came one at a time, with a lag in between, we were reluctant to open the Partnership for the sake of one new idea. We erred on the side of investment performance rather than maximizing fund size. I know this is not how the industry thinks and behaves, but at Nomad we see our job as running an investment partnership first and commercial enterprise second.

7.Sources of mis judgment:

1)Doing what the crowd does rather than thinking independently.

2)Availability of the evidence and over weighing on the same.

Looking around you is the most important skill, and is largely innate, although Professor John Stilgoe at Harvard is trying to teach it and wrote an interesting book recently entitled “Outside Lies Magic”. In the markets, investors tend to latch on to what can be measured, aided by the accountants and to some extent by their own laziness. But there is a wealth of information in items expensed by accountants, such as advertising, marketing and research and development, or in items auditors ignore entirely such as product integrity, product life cycles, market share and management character (this is not an exhaustive list!).

3)Inability to perform probability-based thinking.

Understanding the value of a company involves assessing the likely outcomes given management behavior and competitive forces and weighing the probable. outcomes in a valuation. So, an inability to arrange outcomes in probabilities is a considerable error causing bias in investors decision making processes and is behind many mis- valuations.

4)Lack of patience.

In the beginning of the annual general meeting of the Berkshire Hathaway Company they show a video in which Buffett is asked what the main difference between and himself the average investor is, and he answers “patience”. There is so little of it about these days: has anyone heard of getting rich slowly? Jack Bogle, founder of the Vanguard Group, claims that the holding period for stocks is down to 10 months and the average mutual fund is held for 2 years.

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A letter a day!

Letter #06 2006

1.Two handy investment models:

1)Any superiority an investment process may have will only emerge with time, so patience is important.

2)Stock markets posts prices every day. The prices the market sets reveals information about a company’s prospects which may or may not provide an opportunity, it is up to investors to either take the market up on its offer, or wait for another price, another day.

2.Index should not be your benchmark.

Zak and I have witnessed many investors make terrible investment decisions from thinking via the index. The most common mistake is to view the index (indeed any index?) as a risk free “home”. That this disposition still exists after the irrational index bubbles that preceded the Asian crisis and technology collapse may be testament to the strength of the marketing skills of the financial establishment. Once the index is seen as risk free the mistakes that follow cascade and include: requirement to have an opinion on everything inside the index regardless of one’s circle of competence, an unwillingness to invest in other better opportunities, and over diversification. These three mistakes destroy a lot of capital.

3.Good investing is a minority sport, which means that in order to earn returns better than everyone else we need to be doing things different to the crowd. And one of the things the crowd is not, is patient.

4.The business outcomes can be more predictable several years out than they are in the near term.

We have no idea where the market will end this year but given corporate strategies, capital allocation and starting valuations, I think we have some idea of how our companies will evolve over the next few years. In other words (at this point economics students may wish to cover their ears) the return from investing in shares can be both increased and de-risked by time.

5.How will you know that you are taking a different view than the crowd?
A clue can be taken from the period that other investors typically hold the shares of the companies you tend to hold.

If Berkshire Hathaway (US), Jardine Matheson (Hong Kong) and Next Media (also Hong Kong) are excluded (these firms are in a class of their own due to either stock illiquidity or investor education) then other investors hold stocks in our portfolio for on average twenty weeks. We expect to own shares for around two hundred and sixty weeks! So, what is going on? It seems to us that most investors look at the accounting outputs of a company (the reported financial data) as a guide to near term price movements and play the market accordingly. As stated in the investment objective section of the Nomad prospectus our goal is to “pass custody (of your investment) over at the right price and to the right people”. That’s what investing is. Zak and I concentrate on a deeper reality: the inputs to future value moves. (I have also attached the how Nick has related this philosophy with the example of Amazon)

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Letter# 07 June’2007

Key learnings:

1.How to have creative thinking?

1)Start thinking about something, gather data to the point of saturation, recognize
anomalies and recognize that you are now stuck.
2)Retreat and simmer, mull it over and a period of incubation ensues with the unconscious mind deployed.
3) Whilst doing something else a solution to the problem surfaces.
4)Go and verify the new solution.

2.Co-relation of scaling laws to investing.

Let us first understand what are scaling laws?

Scaling laws describe the functional relationship between two physical quantities that scale with each other over a significant interval. An example of this is power law behavior, where one quantity varies as a power of the other.

Example:

Why do small animals live for less time than bigger animals, and why do humans live for around one hundred years rather than say, one thousand years, or one year? The simplest of scaling laws concerns body-mass and skeletal strength. As an organism increases in size its body-mass grows with volume (to the cubed) whilst the shear strength of the skeleton only increases with the width of the bones (to the squared, or a power law of 3/2). Without a bigger bone structure,
mass soon overwhelms strength, and the organism collapses under its own weight!

What can investors learn from the scaling laws?

The question that needs to be answered is: why is it predictable that a business will grow from a mouse to an elephant?

Several tenets are important.

1) A business ought to be able to self-fund its own growth, and if the opportunity set is large, then the return on capital needs to be suitably high.

2) Second, barriers to entry should increase with size; that way a company’s moat is widened as the firm grows. To do this, the basic building block of the business, its skeletal structure, is probably best kept very simple.

In short, we want a skeletal structure that can support growth from mouse to elephant without too much skeletal re-engineering.

This is law used by Nomad investment lab in identifying Amazon.( I have attached a full note of the same from the letter)

3.Short term result volatility and stock weighting:

There are 2 ways of portfolio construction:

1)Start with 2 -3% allocation and then reach the desired double-digit allocation.

2)Start with double digit allocation and then slowly reach 2-3%.

The adoption of the second approach will give more volatile results in the short term as there is high % of investment in one stock.

4.Investors are often guilty of chasing the new-new thing far from home sometimes in the name of diversification, or higher returns, or both. Such activity often has more to do with marketing than it does with underlying investment reality.

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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"

  1. 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.

  1. Anchoring: A static, historic vision of a problem; and drift, that is how small, incremental changes in thinking build into a big mistake.

  2. Judging: Speaking very high of an idea that’s a lot of rational thoughts.

  1. 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.”

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