NICk Sleep
NICk Sleep
NICk Sleep
Welcome to The
Investor’s Podcast. I’m your host, Clay Finck, and I am just so excited to bring
you today’s episode covering one of my very favorite investors out there, Nick
Sleep. During last week’s episode, I did an intrinsic value analysis on Dollar
General and Apple using Warren Buffett’s approach to analyzing and valuing a
business.
[00:00:25] Then at the end of the episode, I talked a bit about the lessons we can
learn from Nick Sleep in identifying a great business, buying it at a reasonable
price, and holding it for a very long time. From there, I started reading into Nick
Sleep’s letters and I wanted to put together an episode talking about his overall
investment approach, how Buffett and Munger influenced him and his incredible
investment track record through his fund, the Nomad Investment partner.
[00:00:50] He achieved a stellar total return of 921% versus 117% for the world
Index during the fund’s tenure of 13 years from 2001 to 2014. I also touch on his
home run investments in Berkshire Hathaway, Costco, in Amazon. His Amazon
investment in his personal portfolio got so large in his portfolio that he actually
decided to sell half of it and allocate it to a fourth company, a sauce, which I’ll
be diving into at the end of this episode.
[00:01:24] So be sure to stick around until the end. Also, as I’ve mentioned in
previous episodes, we are running a stock pitch competition for the listeners to
compete. If you’d like to submit a stock pitch and earn a chance to win $1,000,
please visit theinvestorspodcast.com/stock-competition. That’s
theinvestorspodcast.com/stock-competition.With that, let’s get right to it.
[00:01:55] You are listening to The Investor’s Podcast, where we study the
financial markets and read the books that influence self-made billionaires the
most. We keep you informed and prepared for the unexpected.
[00:02:14] Now, like I mentioned in the intro, Nick Fund, the Nomad Investment
Partnership achieved a total return of 921% versus 117% for his benchmark before
fees. The fund achieved an average annual rate of return of 20.8% versus 6.5% for
the world index. Just an incredible difference in how much he outperformed the
world Index.
[00:02:39] Now, Sleep would write two letters per year to his partner. Where he
would outline the performance of his fund, share his investment approach, and he’d
usually outline two companies in each letter that he sent out, discussing what the
business did and why he thought the company was undervalued.
[00:02:55] Originally, these letters were private, but apparently people were
sharing them online, so Nick was upset and went ahead and shared all of them so
anyone can view his letters. He’s a pretty private person and you know, if you
search for his name on YouTube or Google, you won’t find a single interview out
there.
[00:03:11] He was just very private and wasn’t very promotional in himself at all.
Now during this episode, I’m going to be focusing on Nick. But he actually had a
partner in his fund too, Qais Zakaria. You know these two were both very
unconventional investors. I’m going to focus on Sleep because he had written all
these letters, but I think a lot of this really applies to Zakaria as well.
[00:03:35] William Green covered both of them in his brilliant book. Richer, Wiser,
Happier. And again, I’m just going to focus on Nick Sleep during this episode. And
at the very beginning of the letters he posted, he also included a letter that he
wrote to Warren Buffett when he closed his fund, letting him know that Buffett just
had an enormous impact on their investment approach over the years.
[00:03:56] And since that fund was closing, they would be selling the funds
holdings in Berkshire Hathaway. He also wrote that the Nomad Partnership made their
investors $2 billion for their clients, and that Berkshire was a big part of that.
Now, Nick Sleep was based out of London in the UK, so it’s interesting to see how
well versed he was in some of these companies in the us but he did invest in a lot
of companies internationally as well.
[00:04:18] He wasn’t afraid to look in other countries to try and find these deep
value type picks, such as a country like Zimbabwe. Interestingly, Sleep went
through a similar journey as Buffett transitioning from the focus on cheap
businesses or the deep value cigar type plays to the focus on quality businesses.
[00:04:38] In his very first letter in 2001, he stated quote, When we evaluate
potential investments, we are looking for businesses trading at 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.
[00:04:57] Finding all three is rare, and that is why we think Nomad has a material
advantage in being a global fund. This falls very well in line with Buffett’s new
line of think. However, in his 2002 letter he outlined to shareholders the types of
businesses the partnership was to invest in, quote, a few final statistics on the
fund’s characteristics.
[00:05:42] And finally 17% is invested in deep value workouts such as Xerox, where
prices are depressed by temporary factors such as short term profits, debt, or the
legacy of previous management. It is the first category that contains our current
winners in the latter that contains our losers in time. Both will contain winners.
[00:06:46] He talked about the crowd and the influence they have on the markets. He
shared a quote from Fred Shwe in his book, A little wonderful advice quote, When
there is a stock market boom and everyone is scrambling for common stocks. Take all
your common stocks and sell. Take the proceeds and buy conservative bonds.
[00:07:06] No doubt the stocks you sold will go higher. Pay 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 all the bonds, perhaps at a loss and
buy back the stocks. No doubt that the stocks will go lower still.
[00:07:24] 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. End
quote. Now, I thought this was interesting considering the current environment of
rising rates. This is currently crushing bond prices, so bonds are personally
something I totally avoid and that isn’t really the point I wanted to get across
with this quote.
[00:07:48] Sleep making that point that investment timeframes are very compressed
for the crowd. Few investors even bother to assess the real value of a business,
but instead respond to the latest data point that’s in the headlines to determine
where the price is going to go in the short term. So for example, when a high
flying growth stock triples in a matter of months and Wall Street puts a price
target on it much higher than where it’s at, retail investors will flood in because
they believe the share price appreciation will just simply continue just because
it’s gone up recently.
[00:08:23] Wall Street stated that they predicted to just keep going up. You know,
you saw that with gross stocks in 2021, a company would triple in price and Wall
Street would just put a price target that’s higher than what the stock was
currently at. They’re just really looking at short term trends, and they’re
incentivized to get people to continue to buy and sell because they make profits on
the spreads and on the fees that they are charging.
[00:09:07] He said that quote, Those that chase high prices today leave less
gunpowder for the future. In effect, they value future opportunities close to N. So
opportunity cost is partly behind our decisions as well end. Sleep acknowledged
that Nomads key advantage over other investors was patients. He believed that they
were one of few investors in the market who were truly long-term investors, as he
stated, quote, Only by looking out farther than the short-term crowd can we expect
to beat them.
[00:09:37] End quote. And I think there are a number of really good benefits to
taking this long term approach that Sleep and Zakaria implemented. First off, a lot
of the work around researching a business is done. Way up front so you can
understand the business, the industry it operates in, how exactly they make money,
et cetera.
[00:09:56] So once you identify that great business you want to purchase outside of
reviewing the reports every quarter or every year, you don’t need to do much work
after your original purchase. It reminds me of Buffett talking about Apple and that
he treats Apple like his purchase of a farm. You know, he checks on the yield maybe
once or twice a year and see how the farm’s performing, but other than that, he
knows he bought a great company that’s likely to just, you know, continue to
produce those profits into the future.
[00:10:24] And he knows. That there’s quality management in place to take care of
what needs to be done. So he’s really not worrying about the day-to-day operations,
the day-to-day stock movements, you know, he just has that long term mindset and
approach. So again, a lot of the work around this is done up front. So I think
that’s a huge advantage because you can just go out and do other things in your
life after you’ve found those great companies you want to own.
[00:10:48] The second advantage is that you’re deferring your capital gains taxes
for each year. You let the business continue to compound. Warren Buffett referred
to this as an interest free loan from the government where you’re continuing to
defer that tax bill, which is just tremendous because your investments can compound
more forcefully.
[00:11:08] In the end, you really make more money assuming the company continues to
grow in compound capital. You know, it’s really comparing this long term, buy a
great business and let it compound versus continually trade in and out of stuff
every two or three years when stuff gets ridiculously cheap and then goes back to
fair value.
[00:11:54] And it was almost a breath of fresh air to read. Nick Sleep’s work. He
is the pinnacle of what it means to be a long term investor. Next, I wanted to talk
a little bit more about his overall investment approach. In his 2003 shareholder
letter, Sleep outlined the partnerships overall approach. He stated that their aim
is to make investments at prices.
[00:12:38] This outcome would imply a return from purchase price of 50 cents of
around 26% per aum. So from that 50 cent mark to the dollar 62 at the end of five
years after buying at a 50%. So quite strict standards that Sleep is looking for
here. You’re likely listening to this and thinking, Wow, this is amazing.
[00:12:58] Nick was able to get a 26% return with each of his investments. Well,
about half of his picks would not go quite as well as he originally assessed, so
oftentimes these picks would just simply remain flat, which would bring his average
expected return to around 13%, give or take. He believed that their most common
mistake is to misjudge capital allocation decisions.
[00:13:22] By the companies they selected. Nick mentions that most of his Zak’s
time was spent, one, ensuring that the purchase price was at least half of what the
intrinsic value of the company was. And two, ensuring proper capital allocation of
the management team, as well as the sustainability of the business returns in the
long run, the longer investors own shares, the more their outcomes is linked to
these two metrics.
[00:13:47] Some of the listeners might be wondering why investors like Nick Sleep,
Warren Buffett, Charlie Munger, and many of these other greats aren’t interested in
companies that are growing much faster than say, 10 or 20% per year. I was actually
in that camp last year. You know, why would I own a company growing at 10% when I
could own a company that’s growing at 50%?
[00:14:08] While Sleep talks about this? It all comes down to the underlying value.
Nick mentions that companies like EMC, Dell, PMC, Sierra, and Microsoft were big
winners through the nineties. Yet practically no one was holding shares during that
period, at least since, you know, the early nineties in holding all the way
through.
[00:14:28] Nick admits that he missed out on these companies. He said in regards to
Dell, he said he likely would have concluded that it was likely that the business
would not succeed, so he’d just look somewhere else to invest. He then referenced a
study by Michael Goldstein at Empirical Research that said that 80% of high growth
companies would have their growth slow within five years in 90% of companies would
have their growth slow within 10 years.
[00:14:54] This is why so many value investors avoid the likes. Apple, Amazon, and
Alphabet in their early years. Very few foresaw the growth runway that these
companies had in them. Bill Miller and Nick Sleep ended up seeing through the
negativity that spooked investors around Amazon, and they just profited
tremendously as you’ll come to find out.
[00:15:17] The big reason why so many growth stocks don’t continue their
extraordinary growth is because fast profits and fast growth encourage competition
and capital flows into an industry and they really just eat away at those profits.
I think Peloton is a great example here. You know, they got a lot of attention.
[00:15:33] They were growing really fast, and then you see all these other bike
companies that have very similar products just flood in. You know, slightly
different variations of the product or maybe offer it at an even cheaper price and,
you know, the growth really gets attacked in that manner. I wanted to shed some
light on Nick thoughts on portfolio diversification as well.
[00:16:16] Bill has actually been on William Green’s podcast. Richard Wiser,
happier. If you’re interested in checking that out, I’ll be sure to link that in
the show notes. Bill Miller followed the idea that the more sure that the
investment thesis would work out, the more of your assets you should invest in that
idea.
[00:16:33] Funnily enough, Bill publicly stated on William’s podcast that he has
over 40% plus of his net worth in Amazon stock and 40% plus in Bitcoin as well,
meaning that over 80% of his net worth at the time of the podcast recording was
writing on just two assets. Bill and William discussed both of these during their
conversation.
[00:16:54] If you’re interested in learning more, Not only did Sleep and Zakaria
look up to Bill Miller as an investor, but Bill Miller also admired them as he
personally invested in the Nomad Fund. The problem with this approach to having a
concentrated portfolio is that you don’t know the true probability that an
investment actually works out.
[00:17:13] You might have, you know, super high conviction, but you might be
missing something or you know, the market may not see what you’re seeing. You can
only make an educated guess based on the facts is the truth of the situation. The
average fund manager likely has no clue how an investment will work out, so next
day set.
[00:17:31] They over diversify for marketing purpose. And make their clients more
comfortable investing with them as returns are more stable and in line with the
benchmarks. A highly concentrated portfolio with only the best ideas will lead to
more volatile results year over year, but a much higher, longer term return.
[00:17:51] Assuming that the right mix of investments are selected in 2006, one
sixth of assets were invested in Amazon from the Nomad Fund as they had high
conviction that it would be a strong out. They knew all too well that it would lead
to the fund being much more volatile than your typical fund, but it did not bother
them one bit because they fully understood what they owned.
[00:18:14] But Nick knew that only a few big things in life were knowable and
within those big things, only a few select investments are available. Since only a
few things can be known for sure, this means that adding more companies to his
portfolio, just for the sake of what the finance industry would call diversifying
in Nick’s view, would not decrease his risk, but increase it.
[00:18:37] Just like how many of the world’s wealthiest people got rich off one
company. Think of Jeff Bezos, Warren Buffett, Bill Gates Sleep was taking a similar
approach by riding the wave of these spectacular investments as well. I also found
Sleep’s commentary around performance and benchmarking his performance to be quite
interesting.
[00:18:57] He believes that the way in which he invests will lead him to
underperform the overall market during bull markets and outperform the market
during bear markets. Now this makes sense with many of his traditional value type
picks. But I think with a company like Amazon, I think actually the opposite is
true.
[00:19:14] Despite this thinking around how they might perform relative to the
index or their benchmark, they really don’t pay much attention to it at all because
of the somewhat randomness of the market. What they are really focused on is the
long term and what they call destination analysis. They see the market index or
what other funds uses their benchmark as something that is simply offered by the.
[00:19:37] And it’s just one of many potential investment opportunities. They can
place their money. Nick and Zak are targeting a certain long term return and they
can invest in a number of stocks available on the market. They think of each
opportunity very probabilistically. They don’t invest in the index simply because
they can find better opportunities that offer them a higher probability of reaching
their desired destination over the long run.
[00:20:28] In this 2006 year-end letter, Nick stated, “Our goal is a track record
to be proud of. We wish to accomplish something meaningful, and to do that we aim
to earn returns over time on par with those investors we greatly admire. In no way
do we guarantee returns, but if we can approach their results, then over time we
will beat the index too.”
[00:20:49] I find this perspective fascinating. I know so many smart investors that
simply refuse to buy anything button index fund for their portfolio or for the
majority of their portfolio. There’s nothing particularly wrong with that approach,
but I think if you’re so dead set on only purchasing the index, then I think when
those rare, fantastic opportunities do come along, you’re not giving yourself the
opportunity to capitalize on.
[00:21:43] One of my favorite parts about reading Sleep’s letters was what he was
writing during the great financial crisis. What were his thoughts when his fund was
down substantially, and did his approach change at all? To give the audience a
frame of reference, the overall market peaked around October of 2007 before it
proceeded into a bear market.
[00:22:04] In later 2008 is when the waterfall of selling really occurred, and
investors were really tested with their conviction and their holding. At the end of
2008, the Nomad Fund was down 45%. While the World Index, he references in his
letters was down 40%. Despite the atrocious performance in 2008, Sleep stated that
these times are the best of times for an investor, which is pretty timely to
mention.
[00:22:32] Given that today we’ve seen lower stock prices in 2022. In his 2008
letter to shareholders, he discussed the total optimization of everything in our
day to day. From investors wanting to invest every dollar possible to businesses
that want to take on debt if they have the capacity to, to our workday filled with
work, to every single minute.
[00:22:55] When we are in the office. Everything in our capitalistic world seems to
be maximized by so many. As to lead, put it. Capitalism does not teach Slack. It
teaches optimization in quote, and I can’t help but think of what we saw in 2021.
You’d see these headlines from Ray Dalio that Cassius Trash and every dollar you
don’t have invested in some way is essentially a melting ice cube that will
eventually become worthless.
[00:23:24] Now we see the ARC funds and cryptocurrencies crashing down 70% plus and
interest rates are on the rise, pushing the prices of all assets down substantially
as the federal reserves slammed the brakes on the economy. Now in the short term,
the output maximization does look like a great idea. The flaw, however, to putting
money to work immediately and being fully invested is to assume that all relevant
opportunity sets are available immediately.
[00:23:55] Say one invests in a company with an expected return of say 8%. You
know, not too bad. However, by making that investment, you’re giving up the
opportunity to invest in a much better opportunity, should it come along in the
future. This isn’t to say that when you believe that the market is overvalued, you
should go a hundred percent cash or anything until a ripe opportunity comes.
[00:24:16] I think Sleep does make a strong case to use. You know, kind of this
Buffett like approach of having extra cash on the sidelines in case incredible
opportunities do happen to come along. He calls this having a little bit of slack
in your processes and to not always be focused on optimization. Sleep. Also
recognized that the businesses he really knew well and really loved were businesses
with scale economies.
[00:24:43] These companies like Costco and Amazon that he owned, they were doing
just as well in the bad economic times as they were in the good While overall. I’ll
be diving into the scaled economics model here in a little bit, but I want to focus
on the financial crisis now. While overall retail sales were down 10%, Amazon’s
biggest day leading up to Christmas was 16% higher in 2008 than in 2007.
[00:25:09] Even though many of the companies they owned were down 50% in 2008, the
businesses themselves still continued to surge ahead. He said that Amazon was
priced as if it wouldn’t grow in the future, despite them seeing some of the best
growth prospects they could ever imagine for a company. By mid 2009, Amazon’s
revenues were up over 60% over the past couple of years.
[00:25:33] Yet the stock was all doom and gloom. The business did so well. It was
almost as if a credit crisis made Amazon’s business even stronger than it would’ve
been otherwise. Here’s how Sleep rounded out his 2008 letter quote. The commentary
in the press is uniformly gloomy, and this is serving to depress share price.
[00:25:54] What we know is that prices are lower than a few years ago in corporate
behavior is improv. We mean no disrespect to those unfortunate enough to lose their
jobs or caught up in other people’s. Too busy to think mistakes and scandals. But
from the perspective of an investor, there is less to worry about today than there
was a few years ago.
[00:26:36] It is in this environment that people sell their GTOs for 750 pounds.
Take heart and look to the horizon. End quote. Now this reference to the GTO is
referring to a story he told about a motor car that sold for just ridiculously
cheap. The story itself isn’t all that important for the intentions of this
episode, but how he relates the story to himself I found interesting.
[00:27:02] He said that the collector thought outside of the box, rolled up his
sleeves, did some analytical work, and found a contrarian investment opportunity
with great growth potential that few of his peers recognized at the time. He luck
in at a low price, owned it forever, and in the end it did not matter what price he
paid, particularly as the growth and the underlying value made his purchase one of
the best investments of all.
[00:27:27] He says that Zak and him aspire to such a roadmap. I just loved the way
he communicated and how he was thinking during the total market turmoil. He was
clear that his investment approach wasn’t going to change, and despite the total
calamity in the markets, he was straight up telling shareholders that the
underlying value of many of the businesses they owned were improving, thus giving
investors the opportunity to buy great companies for cheap prices as a reference to
just how right Sleep was.
[00:27:58] At this time of utter chaos, since the end of 2008, Berkshire today is
up 344%. Costco is up 825% and Amazon is up 4008%. I repeat 4008%. Now, I expected
the recovery of the Nomad Fund to be pretty good relative to the index in the year
to come in 2009, but I did not expect it to be this good. To round out 2009, the
Nomad Fund was up 71% while the World Index was up 30% from 2009 through 2013,
Nomad returned investors 404%.
[00:28:41] Now at the very end of the letters that Sleep published for the world to
see. I was somewhat surprised to see that he mentioned that for his readers who
wanted to learn more about him and his overall investment approach to go and read
William Green’s book, Richer, Wiser, Happier, you know, just coming from someone
that’s so private and won’t do any interviews and is not promotional at all.
[00:29:02] I just love how he mentioned William’s book at the end of his letters at
the very end, because he released them in 2021 actually. He stated, quote, William
has written the kind of book that we would love to have written, but know that we
lack the requisite skills. We are sure you will enjoy the read end quote.
[00:29:22] This is quite a statement from someone who has extraordinarily high
standards for quality, and I agree that you’ll definitely enjoy reading that book
from William if you for some reason haven’t yet. In William’s book, he highlighted
Sleep’s intense focus on quality as Sleep. You really want to do everything with
quality, as that is where the satisfaction and peace is.
[00:29:44] Sleep took this quality approach to investing quite literally as he saw
the investment partnership as a laboratory test of sorts on how to invest, think,
and behave in the most high quality manner possible. I pulled that brilliant idea
from William Green’s book. He really wasn’t interested in making a fortune in the
investment business.
[00:30:05] It’s almost as if he set out to prove to Wall Street that there is an
ethical way to doing business in the investment world. There were many times that
they would actually turn away investors if they didn’t feel that there were enough
ripe opportunities at the time. To have somebody who has as good of an investor as
him and Zak to turn away investors knocking at the door, I’m sure was just totally
unheard of in the investment industry.
[00:30:32] And on top of that, they charged a tiny, minuscule management fee, you
know, at least compared to traditional standards. They got 20% of the profits above
a 6% hurdle rate, and instead of the usual one to 2% fee charged by investment
managers, as the fund actually fell short of its hurdle, they would refund a
portion of those previously earned fees to shareholders.
[00:30:57] To Nick and Zak, it was really, truly all about quality and the money
was totally secondary for what they wanted to achieve. Sleep went on to say that
the fund closed in early 2014 for a number of reasons, including the headaches that
regulators were providing ’em, as well as the desire for independence and a new
adventure for them to explore.
[00:31:18] And I believe that Sleep went down the route of philanthropy and
charitable causes after closing his fund, the fund at the end of its tenure had
grown to around $3 billion in assets. Now if you’re interested in why Sleep was
just so obsessed with quality, I found it interesting that he had this one book
that had just been an enormous impact on him. It’s called Zen and the Art of
Motorcycle Maintenance. I have not read this book. I plan on definitely taking a
look at it. And this is a book that Nick actually recommended that Zak read when
they originally started the Fund. So for those interested in learning more about
his quality approach, that might be an interesting story that you’d like to check
out.
[00:32:00] Now one quote that stuck out to me at the very end of his letters, he
said, quote, Investors can think their way to success without seeming to work in
the traditional sense in the payoff in capitalism from stock picking can be
extraordinary. End quote. I just really liked that quote, and I thought it was one
of his many profound statements.
[00:32:21] Sleep and Zakaria ended up retiring as fund managers at 45 years old,
and since then, they’ve actually managed money quite well for their personal
portfolios as Sleep. Tripled his wealth in the first five years of retirement,
according to William Green’s book. Next, I wanted to walk through his overall
thoughts on Costco and Amazon and why he loved these investments so much.
[00:33:26] A key differentiator for Costco relative to other retailers was that
they implemented an everyday low pricing strategy and they never marked up their
products more than 15% from what they bought them. While Walmart at the time had
markups of around 20%, and the industry standard was really around 30%.
[00:33:45] So Costco customers know that Costco is giving them a great price on
their products, and there isn’t really any marketing schemes to offer temporary
discounts on their products. You know, every time you go into Costco and make a
purchase, You’re getting a great price, at least relative to what they pay to their
suppliers.
[00:34:04] Now, what I like to look for and find in a business is what Jim Collins
popularize, which is called the flywheel effect. The Costco model definitely had a
flywheel effect as well. The low prices would lure customers in, which means that
Costco receives more profits as a result of the greater number of customer.
[00:34:23] Costco would then use those profits to go out and open more stores
wherever they found the best opportunities to do so. Since Costco then had more
stores, they had more bargaining power over their suppliers, which in turn would
incentivize even more customers to join and purchase that membership, and so on and
so forth.
[00:34:42] This was the Costco business model, The standard markup strategy they
used continued to push the cost savings onto the customer. Build that trust with
them to keep coming back year after year, after year to do more and more shopping.
Now, Sleep refers to the Costco and the Amazon business model actually as the
shared economics model.
[00:35:03] Both of these companies are super cost efficient, so they can offer
super low prices. So as the business grows, their prices are able to go lower and
lower, which begets more growth. So as the business grows, their moat grows and the
quality of the company and the amount of time the company is able to withstand
extends as they grow, as they build more customers and build more stores.
[00:35:27] So customers actually benefit from the growth of the company. For a
company like say Nike, that has a high margin business, the same really can’t be
said as each year they are paying a high margin for Nike’s products, and Nike’s
really relying on that brand with loyalty. But for Costco, you’re getting better
prices each year.
[00:35:48] As the company grows in, the economies of scale are shared with the
customers. At the time, Sleep estimated that Costco could fund itself to grow at
around 14% per year. From that point, he said that this level of growth was much
more sustainable than the companies that the retailed crowd was chasing at the
time.
[00:36:07] With growth of 30% or more for many of the companies, he estimated that
Costco could reach a thousand stores in the. And 200 stores in the uk. While at the
time they had 284 in the US and 14 in the uk. So a ton of room for long term
growth. According to his assessment of the market, Costco’s stock peaked in 2000 at
around $55 per share.
[00:36:31] And Nomad purchased at $30 per share according to his 2002 shareholder
letter, and they ended up purchasing more over the years. Of course, he stated that
he believed a reasonable valuation for Costco was north of $50 per share at the end
of 2002. And in his letter he stated, Costco is as perfect a growth stock as we
have analyzed and is available in the stock market at close to half price.
[00:36:57] In 2004, Costco was trading at a earnings multiple of 24, while the PE
ratio today is around 35, 36, so we have a 50% higher. Today, if I had to guess
why? Part of it is likely due to the market’s appreciation of the quality of the
business Costco has, and the other part is probably because the overall market is
just priced higher today than in 2004.
[00:37:23] A lot more people know about Costco now than they did then too. So he
also explained how Costco is so difficult to compete with because they’re just so
giving to the customer. Wall Street, you know, oftentimes urges companies to give
back to the shareholders rather than the customers through things like share
repurchases through dividends.
[00:37:44] This is exactly what most shareholders want, including Wall Street. But
Costco gives a lot of their earnings potential actually, to their customers, and
this in turn leads to a stronger business that is more likely to sustain far, far
into the future. It’s truly a business that focuses on the long-term.
[00:38:03] Which aligns right with Sleep’s investment philosophy. When purchasing a
great business, Sleep oftentimes would interview management of a company, and he
just saw that the management team was so serious about never marking up their
products more than 15%. You know, there might be a time where they can make a
killing on some specific product, they get at a huge discount.
[00:38:22] But management was like, “No, we’re going to pass on these savings to
the customer.” So they just did it over and over and over. And the model has
definitely. One idea that Sleep wrote about was related to business quality and
moats. If you’re holding a business for the long term, it is extremely important
that the company has a strong moat.
[00:38:40] The difficulty really lies in assessing the strength of a company’s m.o.
because it’s not necessarily a number you can just point to on a balance sheet or
on an income statement. It’s more of a qualitative metric that’s up to the eye of
the beholder. Sleep talked about the idea of the robustness ratio, which analyzes
how much a company saves their customers relative to how much money the company
actually makes.
[00:39:05] In theory, a business that saves customers a ton of money and makes very
little money relative to how much they save their customers, you know, that’ll be
very hard to disrupt, at least relative to a business that has high profits
relative to what they save their customer. This concept definitely applies to
Costco because with the way their business is set up, it actually discourages
competition because of how much investment it would take to make the same amount of
money that Costco does.
[00:39:33] On top of that, you’re already competing with a really strong brand that
Costco is built for their customers. Sleep estimated that for every $1 in profit
Costco, Customers were saving $5. Now, he actually came up with this idea of the
robustness ratio from Warren Buffett when he described Geico. Buffett stated in his
2005 annual letter that Geico was saving their customers roughly $1 billion in
earning $1 billion in pretax profits as well.
[00:40:02] So in Buffett’s eyes, it was clear that Geico had a moat. Because of the
enormous cost savings they passed down to their customers relative to the profit
they receiv. Sleep took that idea and applied it to Costco, claiming they had a
moat as well, in that the quality of the moat could actually be quantified through
the robustness ratio.
[00:40:21] You know, just using one metric to get an idea of how strong it was. He
makes it clear that the robustness ratio isn’t the end all, be all of a mote. It’s
just one indicator to get a rough idea. And even if the ratio is shrinking over
time, it doesn’t necessarily mean that the moat is weaken. In Costco’s case, you
want to offer customers.
[00:40:41] As much value as possible early on in the business cycles, so then you
can continue to get those early referrals from customers. And then maybe later on
you can increase the price of the memberships or gradually increase the prices in
the stores. At the end of the day, Costco’s only real competitor was Sam’s Club.
[00:40:59] Both of these businesses were growing and Costco still offered really
competitive prices relative to Sam’s Club because of the flywheel effect. Costco’s
competitive position was only going to strengthen, and the business was destined to
grow. Over time, as profits were reinvested back into the business, many stores
were opened and more customers were acquired under the membership model.
[00:41:22] Another item I think that is at the root of all great businesses is
incentives. You can think about what have been the incentives and what has led to
the growth of Costco’s business and in turn the growth of their stock price. Let’s
look at me personally on an individual level because we know that individuals are
the customers of Costco.
[00:41:43] If I know that Costco provides relatively high quality products at very
competitive prices, then I am incentivized to shop at Costco versus, you know, the
many other places and options I have because I know that Costco will actually save
me money on the bulk items I want to buy or the bulk items I need.
[00:42:03] You can then look at Costco’s suppliers. The biggest and the best
businesses are incentivized to offer their products in Costco stores because Costco
has millions of people walking through their doors every single day. You can look
at the executive team. If the executive team holds a lot of Costco stock and have
done so for many years, then we know that they are actually incentivized to drive
long-term shareholder growth in the value of those shares.
[00:42:28] You know, once you start to see those incentive. Possibly get thrown
off. That’s when you start to see undesirable results. In my opinion, if management
starts to give on their commitment to low prices, then that could cause, you know,
customers to lose trust in Costco. Am I lead customers to want to shop around and
try and find the best deal.
[00:42:49] You know, if the management team has stock options that incentivize
results for this quarter rather than the quarter, five or 10 years from now, then
that really changes their incentive structure. So, you know, Charlie Munger’s huge
on incentives and I think it’s something definitely worth mentioning. Now, I wanted
to turn my attention to Amazon.
[00:43:07] You know, many people are familiar with Amazon’s business model, so I’m
not going to get too much into. And despite Sleep’s criticism of many growth
companies, this did not stop him from recognizing the tremendous potential in
Amazon. And I find it interesting how Bill Miller and Nickle both owned Amazon.
[00:43:25] You know, they seem to be. Acquaintances are friends and you know,
really admired each other. So I’m really curious how much discussions they had in
discussing Amazon because they’re both, you know, two of the greats. What Sleep was
seeing in Costco was very similar to what he was seeing in Amazon as well.
[00:43:44] Many other investors were caught up in Amazon’s reinvestment back into
the business, which at the time seemed to hurt shareholders as they didn’t report
any bottom line earnings, but Sleep saw that Amazon wasn’t optimizing for the
current quarter. They were really optimizing for the long term shareholder value
and the sustainability of the business.
[00:44:04] Amazon actually also had a membership fee similar to Costco with Amazon
Prime, and that captured customers into their network and further incentivized
customers to shop with them. So Wall Street again wanted to see the company produce
profits today, but Bezos was patiently reinvesting back into the company and laying
the groundwork for growth.
[00:44:25] No one on Wall Street could comprehend just mind blowing growth. Once
Amazon released Amazon Prime. In Nick and Zak’s mind, it was game over. They
charged an annual fee of $79 for two day shipping, as well as some other free perks
such as free movies and TV shows in the short run. This definitely did not help
Amazon’s bottom line.
[00:44:47] However, in the long run it was setting the stage for something
extraordinary Sleep. Said that he knew exactly what game that Amazon was playing
because he had seen it in Costco and Amazon was just a supercharged version of.
They first started purchasing Amazon shares around $30 per share, and they actually
put 20% of the fund’s assets into Amazon’s stock.
[00:45:11] This move was quite controversial as one fourth of the partners took
their money out of Nomad as they feared that the fund was too concentrated into one
company, one of Bezos’s early shareholder letters stated. Our judgment is that
relentlessly returning efficiency improvements and scale economies to customers in
the form of lower prices creates a virtuous cycle that over the long term, leads to
a much larger dollar amount of free cash flow and thereby a much more valuable
amazon.com.
[00:45:42] Out of all the business models out there that they had studied the
scale, economy’s shared model was in Sleep’s mind, the best that they could find.
They studied this business model from Walmart’s reports back in the 1970s, and now
they applied it to Costco, Amazon, Dell, Southwest Airlines and Tesco. I just loved
one of the statements that Sleep made when discussing Amazon.
[00:46:05] In his 2006 shareholder letter, he said that traders have many small
ideas and we have one big. Good luck to them. Picking up pennies in front of a
juggernaut is just not how we behave. He also thinks that he thinks Bezos would
actually run a good investment fund as good. Investing in good business decisions
are synonymous.
[00:46:28] Bezos does not control the timing of the payback of the reinvestment
back into the business. Just as Sleep doesn’t control the timing of nomads
performance. But the ever widening of the moat surrounding Amazon largely
determines whether his investment will be a success. He just had to have the
patience to wait.
[00:46:47] One big mistake that some investors make is finding a winning company,
but end up selling that company too early. Nick and Zak did not make this mistake
with. At the time, they knew full well of this mistake as they knew of others who
had sold out of Walmart or Microsoft. Early on in the company’s growth timeline, as
he said, quote mathematically, this error is far greater than the equivalent sum
invested in a firm that goes bankrupt and quote, However, there is good reason that
many investors eventually do sell their winners because research shows that most
growth companies eventually stop growing.
[00:47:26] So Amazon, Microsoft, Walmart, these are almost the outliers in the
data. And you know, when a growth company does stop growing, the stock price
eventually does take a hit because of that. So the market takes into account the
fact that most companies do end up eventually failing by discounting. All stocks.
[00:47:45] What this actually does is discount the companies that don’t fail as
well or just continue to grow. This gives investors like Nick Sleep a huge
advantage because he’s able to see what 99% of other investors aren’t seeing. He’s
seeing that 1% type company that sees where the company’s heading very early on,
and he’s one of the few that’s able to get ahold of shares early at an extreme
discount, and he is one of the few that’s willing to hold on from the very
beginning into the practically indefinite future in Sleep’s mind.
[00:48:19] And since Sleep is an investor that is pretty concentrated, he’s willing
to do that extra additional work required to ensure when he finds those quality
companies, he’s able to take that extra step and dig deeper into the financials and
the management and interviewing the management to ensure he is correct in what he’s
seeing in the business.
[00:48:39] Whereas most managers are really spread out and diversified and they’re
not able to do the same level of research. Related to selling your winners. Active
managers like to make it look like they’re simply being active or they’re just
doing their job. When an active manager sells a company, people will just assume
that they’re making a wise decision because they’re taking some action and to take
that action.
[00:49:03] They must have put a lot of thought into it. While most people don’t
realize that not doing anything is also a decision, it doesn’t necessarily require
any action at all. Charlie Munger has been quoted saying that he sees inactivity as
a form of intelligence and that the real money is made by sitting on your
investments.
[00:49:50] Back in 2009, Jeff Bezos went on to even say that advertising is the
price you pay for having an unremarkable product or service. Quite an interesting
quote. In a Wired magazine interview, Bezos also stated that there are two ways to
build a successful company. One is to work very, very hard to convince customers to
pay high margins.
[00:50:12] You know, a company like Nike or Coca-Cola. The other way to build a
successful business is to work very, very hard to be able to offer customers low
margins. You know, companies like Walmart, Costco, Amazon, aso, they both work.
Bezo said that Amazon is firmly in the second camp. As we all know, it’s difficult.
[00:50:32] You have to eliminate defects and be very efficient, but it’s also a
point of view. We’d rather have a large customer base and low margins than a small
customer base and higher margins. This isn’t to say that all successful businesses
shouldn’t advertise. I just think it’s a statement to try and communicate who Nick
Sleep really is.
[00:50:53] Again, if you look him up on Google or YouTube, you aren’t going to find
a single time he has appeared in the media, been in an interview. It’s just so
uncommon today where many people will take advantage. The opportunity to get behind
a mic, get in front of a screen, and be in the limelight. But all there really is
to him is what comes from his letters.
[00:51:12] So we’re going to work off of that as well as what’s in William Green’s
book as well, of course. Although we don’t know exactly what Sleep owns in his
personal portfolio today. Luckily we can actually see the holdings in one of his
charities called I G Y Limited Investments. This charity files A 13 F and shows
their holdings, and not surprisingly, at the end of Q2 2022.
[00:51:37] The charity only held three stocks, a 37% position in Costco, a 37%
position in Amazon, and a 25% position in Berkshire Hathaway. So those are the
three holdings In his charity in William Green’s book, he stated that he also
purchased a fourth company, which is aso, probably a company many of the listeners
haven’t heard of, unless they’ve studied Nick Sleep before.
[00:52:25] So in 2018, Sleep sold half of his Amazon position after it had a
sizable run up in price. And he told William Green that he had invested that money
into AAU a year or two later. Sleep does mention AAU and his letters a few times,
mentioning that they are a business with the shared economics model similar to
Amazon and Costco.
[00:52:45] That their ceo, despite becoming wealthy, is as excited as ever to work
in the business. Now, let’s talk about what ASOS does. I’m going to do some
analysis of the business and give my general thoughts on it as Sleep hasn’t talked
all that much about it, really in his letters. According to ASO’s annual report,
they are an online fashion retailer for fashion loving 20 somethings around the
world.
[00:53:11] Through their marketing app and web experience, Assos customers can shop
a curated of 90,000 products sourced from 850 plus of the best global and local
third party brands. Alongside our mix of fashion led in-house labels, I tried to
look up this stock in our t I P finance tool and it actually doesn’t show up as
they are headquartered in the UK in London.
[00:54:01] 20, rose back to $77 and early 2021, and now it’s all the way down to $6
and 50 cents. So quite a rollercoaster ride and quite low today compared to where
it’s been in the past. Very volatile stock. It’s honestly pretty crazy to me to see
how far it’s dropped to today, and the covid low in March, 2020 was roughly $13 per
share, and now the stock is even 50% below the Covid low in March, 2020, so quite
interesting.
[00:54:34] Although the stock is very volatile, the growth in their revenues and
gross profit have been great. Now these numbers are in British pounds rather than
US dollars. From 2017 through 2021, revenue grew from 1.9 billion to 3.9 billion
British pounds. A 19% annual growth rate and gross profit grew from 958 million to
1.77 billion British pounds, a 17% growth rate in their gross profits.
[00:55:04] This looks and sounds great, but their net income is where the company
isn’t nearly as consistent as they are a very low margin business. Their net income
available to common shareholders was 64 million in 20 17, 80 2 million in 20 18, 20
5 million in 2019, 113 million 2020, and 128 million in 2021. The net income for
the trailing 12 months is down to 33 million, which is probably why this stock has
taken the beating as of late, and I’m actually quite surprised that the market has
punished the stock.
[00:55:37] This. The volatility in the net income does make a lot of sense for a
low margin business like asos, just because a small change in their net income
margin leads to drastic changes in the net income on a percentage basis, at least.
For example, if their margin increases from 2% to 4%, well that doubles the
company’s net income.
[00:55:58] All else equal. When I was trying to figure out why the stock was down
so much, I did come across a Bloomberg article that August sales came in lower than
expected, and sales growth was only 2%. The article also noted quote, Shoppers are
navigating the highest inflation in four decades in the uk, and there are signs
that they’re cutting back on purchases of clothing and other non-essential items in
quote.
[00:56:25] The company also had a boost from Covid as more people were shopping
online. But I don’t see that secular trend to online shopping stopping anytime
soon. So it’s good to see the company is positioned in a way to work with those
secular trends. Although the recent growth hasn’t been great because of inflation,
the year over year performance I’m seeing in their annual report actually looks
pretty good.
[00:56:50] From a high level. If the business is able to continue to grow and fend
off competitors, it appears to me that it’s actually trading at a pretty cheap
price. Now that is a huge if because ASOS is in the clothing and retail business,
which is very competitive. If you just normalize their net income to something like
a hundred million British pounds, convert that to usd, which is $113 million.
[00:58:00] All right. That concludes my episode on the brilliance of Nick Sleep.
Since I find how investors like Nick Sleep invests so fascinating, having this
approach of owning the highest quality businesses for decades, I’d love to hear
from the audience about companies they believe fit into this category.
[00:58:19] 2022 has been a year where just about any company that isn’t producing
much cash flows today are getting absolutely crushed, meaning that investors who
dig underneath the surface may be able to find the next great compounding machine
trading at a price well below its intrinsic value. If you have any companies that
come to mind, I would truly love to hear from you.
[00:59:04] All right. That is all I have for today’s episode. I hope you guys
enjoyed it as much as I enjoyed putting it together and sharing it. If you did
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[00:59:24] With that, thank you so much for tuning in, and we’ll see you again next
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