关键词
economy of scale shared、founder-managed business、capital allocation
极具洞见。但有两个不能解决的问题：
1/ 幸存者偏差。当组合最终由少数极好的股票构成（即作者所谓的terminal portfolio）时，长期业绩表现主要由这几个少数甚至是一两个股票贡献，似乎无法回避幸存者偏差问题。 进一步说，当作者认为有terminal porfolio时，似乎在潜意识里低估了世界的随机性，甚至可以说是表现出了过度自信。
2/ 决策逻辑的一致性问题。作者在回答自己的设问为什么不一开始就买入terminal portfolio时，给出的答案是等待合理的价格。但是，当持有了terminal porfolio时，就不再考虑此后价格的高低。如果此后terminal porfolio的估值变得过高，仍然继续持有？那么最初为什么就不能以贵的价格买入呢？This is endowment bias.
A Typical Purchase, Expected Returns, and Portfolio Management
This section was originally contained in the December 2003 letter to Partners.
Our aim is to make investments at prices we consider to be 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. So, what happens when we are wrong? Our most common mistake is to misjudge capital allocation decisions by our 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!
If over five years our mistakes are on aggregate flat, and our mistakes total half of Partnership assets, then this implies a compounded annual return of 13% for the portfolio as a whole2. Not each year, and maybe not for several consecutive years, but over time this level of expectations appears reasonable to us. This model is daftly precise, a little too neat and the one thing we can almost guarantee is that returns will not be exactly 13%. It is important however that we all understand the investment process and time frames involved.
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. It is these factors that occupy almost all our time. – p41-42
The likely evolution of Partnership Investments
In the office we keep a list of companies assembled under the title “super high-quality thinkers”. This is not an easy club to join, and the list currently runs to fifteen businesses. Entry is reserved for the intellectually honest and economically rational, but that alone is not enough. There are many companies that do the right thing when their backs are against the wall, and this list excludes those temporarily attending church. The anointed few are there because they have chosen to out-think their competition and allocate capital over many years with discipline to reinforce their firm’s competitive advantage. Good capital allocation takes many forms and does not necessarily require a firm to grow. The Partnership’s successful investment in Stagecoach has been due to the firm’s shrink strategy, not its growth, although that may come in time. At National Indemnity (an insurance subsidiary of Berkshire Hathaway), the firm’s ability to write insurance only when pricing is good and stand back when pricing is poor, even if revenues decline by 80% and remain depressed for many years, is a wonderful example of capital discipline and good capital allocation. After all, why grow if returns are going to be poor? However, surprisingly few companies have the strength to just sit it out, or shrink, as the pressure to grow is often overwhelming. The clamor comes from within the company (reinforced by poorly constructed incentive compensation), Wall Street promoters and short-term shareholders. When faced with this barrage, the voice of the long-term shareholder often goes unheard. We ask companies with poor economics why they want to grow. And senior management, with their hands on our purse strings, look back at us incredulous at our line of questioning. It is just not that easy to resist the urge to grow, even if economic results look so so. The “super high-quality thinkers” are our best guess of those firms whose shareholders could abdicate their right to trade stock (allocate capital themselves) sure in the knowledge that their capital will be well allocated for years to come within the businesses. This list is a group of wonderful, honestly run compounding machines. We call this the “terminal portfolio”. This is where we want to go. The question is, why is this list not the same as the current Nomad portfolio?
This is not an easy question to answer. But let us return to the church analogy for a moment. When we think about companies, the over-riding analytical consideration is the quality of the business and quality of management’s capital allocation decisions. The longer investors own shares the more their outcome is linked to these two metrics. What separates a corporate hero from a loon is an intellectually honest appraisal of business prospects and armed with that knowledge an appropriate allocation of discretionary resources. There are only two reasons companies behave well. Because they want to, and because they have to. Our preference is to invest in those that want to. If we can find enough of these heavenly opportunities, they will in effect put us out of a job, and you should be pleased with this happy outcome (even we will be pleased, if a little bored). The problem of course 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”.
We can all observe that stock prices, set in an auction market, are more volatile than business values. Several studies and casual observation reveal that individual prices oscillate widely around a central price year in year out, and for no apparent reason. Certainly, business values don’t do this. Over time, this offers the prospect that any business, indeed all businesses, will be meaningfully mispriced. Even the mighty Berkshire Hathaway with its stalwart long-term shareholder base was demonstrably half priced in early 2000. And Marathon bought shares (unfortunately pre-Nomad inception). It is just a matter of time. Those that chase high prices today, leave less gunpowder for the future. In effect, they value future opportunities close to nil. So, opportunity cost is partly behind our decision as well. Today, we have made two investments in wonderful compounding machines, and only one of those is meaningfully represented in the portfolio (Costco Wholesale). What is the probability that say, over the next ten years, a good portion of these “super high-quality thinkers” will be priced at 50c? Our betting is that the odds are reasonable. Even though prices are generally high, the trick is to do the work today, so that we are ready. – p40
Our thoughts on Portfolio Concentration
As the cash is invested, portfolio concentration will rise. In theory, if we could find fifty ideas at equal discounts to value, with equal probability (conviction) of value being realized, then they could all be equally weighted in the Partnership. We could all then look forward to a nice smooth rise in the value of our shares in Nomad, free from the swings a more concentrated portfolio might create. But life is not like that. In reality opportunities in which we are comfortable to deploy capital are rare, and the highest conviction ideas the rarest of them all. The issue then is how much to invest in each idea? Bill Miller, who has run the Legg Mason Value Trust so brilliantly for many years, suggests the use of a system devised in 1956 by J. L. Kelly. A simplified version of the Kelly criterion is that investors should bet a proportion of the portfolio equal to 2.1 x p – 1.1, where p is the probability of being right. The common-sense outcome of this equation is that if one is certain of being right, one should invest the entire portfolio in that idea. Even if one is say, 75% certain of being right the correct weighting remains high at 47.5% ((2.1 x 0.75) – 1.1). But does anyone do that? As far as we are aware, only the early Buffett Partnership portfolios had anywhere near this level of concentration, and then mainly in companies in which Buffett was a controlling shareholder. But is this not the right way to think? If you know you are right, why would you not bet a high proportion of the portfolio in that idea? 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. If you do not share this view, think long and hard about your investment in Nomad. – p37-38
It is commonplace for overall portfolio construction to be as a result of stock weightings built up from one to two to three percent of a portfolio and so on up to a target holding. This means that weightings are anchored at a small number with only outliers reaching double digits. There is another way to construct a portfolio, which is to invert and start at a hundred percent weighting and work down! If fund managers did this, I am sure they would end up with completely different portfolios. Now we are not advocating all the fund in Amazon (well, not just yet at least), but in allowing past habits to anchor portfolio construction we have probably made the mistake of a starting holding that was almost certainly too low. Be that as it may, one effect of having one sixth of the Partnership invested in a volatile stock, such as Amazon, is that our results will also be more variable over the short term. Please bear that in mind in future performance. The volatility does not bother Zak and me one jot. – p121
Economy of scale shared
In the case of Costco scale efficiency gains are passed back to the consumer in order to drive further revenue growth. That way customers at one of the first Costco stores (outside Seattle) benefit from the firm’s expansion (into say Ohio) as they also gain from the decline in supplier prices. This keeps the old stores growing too. The point is that having shared the cost savings, the customer reciprocates, with the result that revenues per foot of retailing space at Costco exceed that at the next highest rival (Wal-Mart’s Sam’s Club) by about fifty percent. – p50
In the office we have a white board on which we have listed the (very few) investment models that work and that we can understand. Costco is the best example we can find of one of them: scale efficiencies shared. Most companies pursue scale efficiencies, but few share them. It’s the sharing that makes the model so powerful. But in the center of the model is a paradox: the company grows through giving more back. We often ask companies what they would do with windfall profits, and most spend it on something or other, or return the cash to shareholders. Almost no one replies give it back to customers – how would that go down with Wall Street? That is why competing with Costco is so hard to do. The firm is not interested in today’s static assessment of performance. It is managing the business as if to raise the probability of long-term success. – p51
There are very few business models where growth begets growth. Scale economics turns size into an asset. Companies that follow this path are at a huge advantage compared to those, for example, that suffer from Barbie syndrome. Put simply: average companies do not do scale economics shared. Average companies do not have a healthy culture. After all, average companies are more like GM than Wal-Mart! The removal of a portion of failure risk from the investment equation creates a huge opportunity for those investors that can see the company in its true perspective and act with a bit of patience. It is a huge anomaly that investors recognize success incrementally when the factors that lead to success, such as scale economics shared reinforced by a strong culture, may be constant. If the early investors in Wal-Mart had understood this, they may have retained their holding along with the, now billionaire, Walton family.
The fund management industry has it that owning shares for a long time is futile as the future is unknowable and what is known is discounted. We respectfully disagree. Indeed, the evidence may suggest that investors rarely appropriately value truly great companies. We can hear the howls of derision from the professional cynics “that’s twenty-twenty hindsight, guys!” Dare we whisper it but, in some cases, we think that greatness may be knowable in, shhh, FORSIGHT! This “longevity of compound” opportunity exists precisely because the average fund manager is attending a different church. Thank God! – p164
Take Costco Wholesale: Costco’s advantage is its very low-cost base, but where does that come from? Not from low-cost land, or cheap wages or any one big thing but from a thousand daily decisions to save money where it need not be spent. This saving is then returned to customers in the form of lower prices, the customer reciprocates and purchases more goods and so begins a virtuous feedback loop. The firm’s advantage starts with 147,000 employees at 566 warehouses making multiple daily decisions regarding U$68bn worth of annual costs. It’s thousands of people caring about thousands of things a little more, perhaps, than may occur at other retailers. No fig leaf here. When Zak and I met Jim Sinegal, Costco’s CEO, Jim suddenly stopped in mid-sentence, his face lit up, “I must show you this” he said and disappeared into a filling cabinet. He emerged with a memo from 1967 written by Sol Price, Fed-Mart’s founder (the predecessor firm to Costco), “here you can have a copy of this” he said, and that copy is framed on our office wall. The memo says this,
“Although we are all interested in margin, it must never be done at the expense of our philosophy. Margin must be obtained by better buying, emphasis on selling the kind of goods we want to sell, operating efficiencies, lower markdowns, greater turnover, etc. Increasing the retail prices and justifying it on the basis that we are still “competitive” could lead to a rude awakening as it has with so many. Let us concentrate on how cheap we can bring things to the people, rather than how much the traffic will bear, and when the race is over Fed-Mart will be there”. [The best summary of the business case for scale economics shared we have come across].
Forty-three years later, almost to the day, and Costco is the most valuable retailer of its type in the world. Cultures that care about the little things all the time are very hard to create and, in the opinion of Amazon.com founder Jeff Bezos, almost impossible to create if not put in place at the firm’s genesis. (It may be worth noting that, in contrast, most businesses cut costs sporadically, often-in response to a crisis, as part of plan B as it were. With their backs to the wall, good costs (investment spending) may be cut as well as bad costs (bloat), with the result that the savings prove counter- productive in the long run). The Welsh insurance company was founded by a man who cared passionately about the little savings, and he institutionalised this orientation into the culture of the firm from the beginning. It was the way they lived; it was part of their raison d’être: it was plan A. And they shared that saving with their customers. Although I was slow to grasp the point, the insurance firm’s advantage was very similar to that which had built Costco and builds Amazon today. – p175
Founder-managed businesses
One reason for this is that the fund is over-whelmingly (over eighty-five percent) invested in firms run by their founders or first-generation management. Just as interesting is that Zak and I did not plan for this! We have ended up with a portfolio of owner-managed businesses as a by-product of our assessment of the quality of the people involved. In other words, these managers earned their way into the portfolio. We feel slightly foolish for not recognizing this trait in advance, but, of course, we would have a bias toward founder-managed businesses (duh!). – p122
The best entrepreneurs we know don’t particularly care about the terms of their compensation packages, and some, such as Jeff Bezos (Amazon) and Warren Buffett (Berkshire Hathaway) have substantially and permanently waived their salaries, bonuses, or option packages. We would surmise that the founders of the firms Nomad has invested in are not particularly motivated by the incremental dollar of personal wealth. When we asked Nick Robertson, the founder of Asos, whose paper net worth has increased hugely since we have known him, whether, now he is a rich man, he has thoughts of leaving, his face lights up with the future possibilities of his firm and says he is having more fun now than ever before. In this aspect of his life he has moved on from monetary rewards driving his behaviour, and we are sure the business will be better for it.
The same is probably true for Jim Sinegal before his retirement (Costco), Lord Harris (Carpetright) and some of the other founders of the firms in which Nomad has invested. These people derive meaning from the challenge, identity, creativity, ethos (this list is not exhaustive) of their work, and not from the incentive packages their compensation committees have devised for them. The point is that financial incentives may be necessary, but they may also not be sufficient in themselves to bring out the best in people. In its own little way, this is why Zak and I are quite relaxed about six percent not being six percent. It was an arbitrary number in the first place, and we derive a great deal of value from the meaning of the work we do (challenge, sense of job well done, identity, creativity and so on) not just from the financial rewards (although we will learn to live with those too!). By having an attitude that is somewhat independent of financial rewards, we are sure that Nomad’s performance in the long run will be far better too. – p209
Zimbabwe as an Example of a Second Investment Model
We have begun making some investments in Zimbabwe and wrote about the background to these in a recent Global Investment Review (also contained in the appendix). The investment case relies upon extreme undervaluation compared to normalised values, so much so that a wait of ten years for normalisation would still yield wonderful results. It makes little sense to discuss stocks we may or are buying (Costco is likely to be a rare exception in this regard) but I can illustrate the investment case by describing Zimcem. This is the country’s largest cement producer (after the local division of Pretoria Portland Cement), with around 700,000 tons of cement capacity and a replacement cost of around U$70 to U$100m.
The firm has no debt and business conditions are awful (general inflation exceeds cement price inflation and product demand is low) but the company is priced on the Harare stock exchange at one seventieth (1/70th!) of its replacement cost. Why is this relevant? So far, we have only discussed one model we use to pick good investments which we call “scale efficiencies shared” as evidenced by Costco (and to a lesser extent Amazon.com). We have little more than a handful of distinct investment models, which overlap to some extent, and Zimcem is a good example of a second model namely, “deep discount to replacement cost with latent pricing power”. Indeed, these two models combined can be used to describe around 45% of total Partnership assets. It was this model that led to many investments during the Asian crisis (such as Siam Cement which has risen twenty-fold from the trough in eight years) and to neighbouring South Africa where Pretoria Portland Cement could be bought at a price of U$20 per ton of capacity in 1998 and is now valued at U$180 per ton. The model is premised upon the observation that the business needs to replace its assets and will require prices which 1. fund the capex, and 2. economically justify the spending. Either that or Zimbabwe will have to go without cement or import from abroad (tricky for this land locked country). In any event, provided discretionary capital is not invested to exacerbate the situation, the supply side remains muted (industry capex is zero) and the business is not nationalised, then the shares ought to do well, in time. – p62-63
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. Finding all three is rare, and that is why we think Nomad has a material advantage in being a global fund. We can look far and wide for candidates and simply are not required to invest in anything that does not fit. – p6
A few final statistics on the fund’s characteristics. Approximately 37% of the fund is invested in quality, difficult to copy, franchise operations such as newspapers, a TV station, motor racetracks, consumer brand names and casinos; 27% is invested in what could be described as discounted asset based businesses such as property, hotels, or conglomerates where fixed assets or cash makes up a large portion of appraised value, and finally 17% is invested in deep value workouts such as Xerox (see below) 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 and the latter that contains our losers. In time both will contain winners. In aggregate we estimate our investments are currently priced by the market at 51% of their real worth, that is to say in our opinion we have bought dollar bills for 51 cents. – p11
It is worth noting also that nearly half of our companies (by number, more by value) are buying back debt or repurchasing shares and at two thirds of our firms there has been notable insider buying. At one third of our investments there has been both insider buying and debt or equity repurchase. – p16
Souter began cutting away the weak businesses, a process Charlie Munger, vice Chairman of Berkshire Hathaway refers to as the “cancer surgery approach”. This often works because there is normally a jewel at the heart of most companies that has often been used to fund new ventures or is taken for granted by impatient management. As the jewel becomes diluted by less successful projects aggregate performance declines and valuations atrophy or even fall. The star in this regard and in which Mr. Munger invested, is Coca-Cola, which in the mid 1980s had become a poorly defined conglomerate including a shrimp farm, winery, film studio and shudder to think, even owned its own bottling plants! As the poorer businesses were cut away, to reveal the jewel that is the syrup manufacturing and marketing operation, the shares of Coca-Cola rose over ten-fold in the succeeding decade. – p18
We were rather struck by some of the early Buffett Partnership letters in which Warren Buffett offers the following advice: return for a moment to the table above “and shuffle the years around and the compounded result will stay the same. If the next four years are going to involve, say, a +40%, -30%, +10%, -6%, the order in which they fall is completely unimportant for our purposes as long as we all are around at the end of the four years”, as we, at Marathon, intend to be. “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. – p22
We are always on the lookout for companies with corporate character that are pursuing strategies designed to create sustainable value. This is no mean feat, and we work hard reading annual reports and proxy statements and interviewing management trying to answer the questions: what are returns on incremental capital and the longevity of those returns, are management correctly incented to allocate capital appropriately, and what is discounted by prices? Once these businesses are found they can be multiyear winners provided capital allocation remains consistent with value creation. All too often however management become sidetracked and misallocate capital usually through diversification or in the words of Peter Lynch, “diworsification”. The result of which is that aggregate returns on capital decline and the share price falls to discount poor performance. Quality of managerial character is therefore important to avoid capital misallocation and it is in the search for such character that we asked an investment bank to perform a simple company search earlier this year (the first search this manager has employed in twelve years). – p22
The best defense is to own enough of the company to influence the outcome. In most cases in excess of 10% of the shares outstanding would suffice. Those that advocate market liquidity of their investments over other considerations might like to bear in mind an investor’s inability to influence outcomes whilst owning a deminimus proportion of a company. – p34
A consequence of price discipline is that one cannot be certain of the size of the investment opportunity in advance. We simply cannot be sure how many people will be prepared to sell to us at our price: it may be 20 shares or 20% of the company. We hope for the latter but more recently have found it to be the former. – p37
What characteristics could one bestow on a company that would make it the most valuable in the world? What would it look like? Such a firm would have a huge marketplace (offering size), high barriers to entry (offering longevity) and very low levels of capital employed (offering free cash flow). – p52
Bill Miller argued that there are three competitive advantages in investing: informational (I know a meaningful fact nobody else does); analytical (I have cut up the public information to arrive at a superior conclusion) and psychological (that is to say, behavioural). 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. – p61
“Any year that you don’t destroy one of your best loved ideas is probably a wasted year”, Charles T. Munger.
“Distinguishing features of probabilistic players include a focus on process versus outcome (I hope I have done some of that today), a constant search for favourable odds and an understanding of the role of time.” That is Patience. – p89
When there is a frenzy of activity in one area of the market there is very often an anti- bubble of discarded companies. In the dot com era these were companies with steady cash flow. Where is today’s anti-bubble? Perhaps in large high quality growth businesses that appear cheaper to us than for many years. It is for this reason that Nomad’s largest holdings are dominated by traditional growth stocks, in contrast to five years ago when we owned the detritus of the New Era boom. It is interesting to note that five years ago although the most despised stocks were extremely cheap, each individual opportunity was relatively small (our investments in Stagecoach and Midland Realty were seven-baggers but the opportunity size was perhaps U$20m each). Today the discount to fair value of the most despised stocks would appear to be much less (doubles over five years are more likely than spectacular multi-baggers) but the dollar size of each opportunity may be greater. The case for a Nomad reopening rests on this observation, and our job over the next few months will be to analyse this proposition. – p98
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. 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. – 120
After the doubling in the share price and the weighty resultant position in the Partnership it would be easy for Zak and me to claim victory, high five, and sell our shares in Amazon. However, the high weighting makes sense given our understanding of the destination of the businesses and the probability of reaching that destination. In previous Nomad letters we have argued that the biggest error an investor can make is the sale of a Wal-Mart or a Microsoft in the early stages of the company’s growth. Mathematically this error is far greater than the equivalent sum invested in a firm that goes bankrupt. The industry tends to gloss over this fact, perhaps because opportunity costs go unrecorded in performance records. For example, our greatest error was the sale of Stagecoach (which has risen ever since sold), not the purchase of Conseco! We wonder, would selling Amazon today would be the equivalent mistake of selling Wal- Mart in 1980 (a similar time period after both companies’ IPOs)? – p121
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. – p129
Tips on how to avoid making mistakes
Understanding how the intellect can become corrupted is probably a life’s work, some mystics would argue many lives’ work. Noticing the mistakes is a huge advantage and so rarely done. What follows are three mistakes that, in our opinion, contribute to more unhappy outcomes than most. These are: denial, that is the reinvention of reality in the mind because the truth is too painful to bear; anchoring, that is a static, historic vision of a problem; and drift, that is how small, incremental changes in thinking build into a big mistake. Add judging to the list as well, in the sense of condemning or exalting: that disposition stops a lot of rational thought, and it is almost ubiquitous. – p130
For example, it is interesting that two of the best performing funds of all time did not disclose their holdings to investors. These 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……In previous letters we have discussed the dysfunctionality of disclosing specific investment ideas. The problems are mainly psychological and include the locking in of an idea, the desire to seem consistent, the wish to seem prudent in other people’s eyes and so forth. There is then the effect of copy-cat investing, brokers trading against us and, as Walter Schloss found out, dealing with nervous-Nellies and so on. – p131
It is quite something to arrive at the end of a five-year period and for Nomad’s returns to be all but zero, and precious little better than the index to boot. This is a very interesting statistic. All that work and effort! Quite what are we doing with our lives, and with other people’s money? Please don’t answer that just yet! One could compare market trough to market trough, broadly equivalent to our performance since inception (suspend judgement if you will and call today a trough) in which case returns are in the order of 10% per annum, and 9% per annum superior at Nomad compared to the average share or broadly a doubling in Nomad’s share price whilst the index did nothing. That is more like it. And it could be argued that, since inception the price to value ratio of the partnership has been meaningfully lowered, implying healthy deferred returns to come. Even so, bear markets are tough and make you test the most basic assumptions. When moments like these arise grace under pressure all- round is the order of the day. – p149
Upon reflection, it is curious that this quiet attitude extends, in its own way, to the companies in which we have entrusted your dollars: Amazon and Costco do not advertise (no shouting here); Berkshire Hathaway and Games Workshop do not provide earnings guidance (popular with baying fund managers and stockbrokers); Amazon, Costco, AirAsia, Carpetright, and parts of Berkshire give back margin to the customer, we would argue that is a pretty humble strategy too. In other words, around two thirds of the portfolio is invested in firms that in some major way shun commonplace promotional activity and they are no less successful as a result.
If one steps outside of stock market listed companies to instead observe private firms run by proprietors and founders, it is the quiet approach that is far closer to the norm. Let’s invert: why are publicly listed companies so promotional about their affairs? Are these companies shouting to inform shareholders and customers or convince themselves? Nomad’s investments may be in publicly listed firms but these firms are also overwhelmingly run by proprietors who think and behave as if they ran private firms. Amazon for example struggles with institutional investor relations so much so that the good people that man the IR department do so knowing that the firm’s founder, Jeff Bezos, thinks their role is all but a waste of time! Poor souls. Bezos was also quite forthright on the subject of product promotion and advertising at this year’s annual general meeting: “Advertising is the price you pay for having an unremarkable product or service”. – p158-159
Seeing, but not Understanding.
How might corporate success be predictable? There are some clues in the world around us. Zak and I observe several business models that work in the long run, and scale economics shared is one of these, witness Ryanair, Wal-Mart, Geico, Southeast Airlines, Tesco, Nebraska Furniture Mart, Direct Line et al. And that is why companies that share scale with the customer such as Carpetright, Costco, Berkshire Hathaway, Amazon and AirAsia make up around sixty percent of the Partnership. It works because it turns size, normally an anchor to growth and returns, into an asset. But I also don’t think this is a great secret.
Investors are broadly rational people (they all knew that Wal-Mart was a wonderful business) and fund managers operate under healthy profit incentives that ought to foster good outcomes, so why is it that no one but the founding Walton family-owned Wal-Mart all the way through? Zak and I were told a story by one of the industry’s most senior fund managers which we enjoyed enormously and might help illustrate the point. In the early 1970s a then, and still today, large successful fund management company analysed its portfolio and discovered that their sale of IBM thirty years earlier had been a huge error of omission. If they had instead kept their IBM shares for the last thirty years, that stake alone would have been larger than total funds under management. No doubt they all agreed to learn from that particular mistake and, as so often happens, went back to their desks and got on with life as before, as if nothing had happened. It is fun to note that, at about the same time, they also made the decision to sell their stake in Wal-Mart, which, thirty years later, would be worth more than their then-to-be funds under management! In terms of dollars of opportunity lost, it is likely to be the biggest single error this firm will make. – p161