0:00

You're listening to TIP. Nick

0:03

and Zach headed the Nomad Investment Partnership from 2001 to

0:05

2013 where they generated legendary

0:08

returns. During this period,

0:10

they turned $1 of their partner's money into $10.21 before

0:12

fees. An

0:15

incredible 20.8% compounded annual gain. And

0:18

due to their partnership structure and minimal fees, their

0:21

partners saw a large portion of these gains go

0:23

to them rather than to just Nick and Zach.

0:26

So today, I'm ecstatic to share my

0:28

learnings from the book, Nick and Zach's Adventures

0:30

in Capitalism by the Rational Cloner. This

0:32

book compiled the information from their shareholders'

0:35

letters into thematic chapters. The

0:37

author gave very concise, but clear, summaries

0:39

of the overarching ideas, then

0:41

allowed Nick and Zach to expand on each

0:43

concept in their own words, using excerpts from

0:46

the partnership letters. Today, I'll

0:48

cover many of the most insightful concepts from

0:50

the book. Nick and Zach have

0:52

one of the biggest affinities to quality that I've ever

0:54

seen. Quality permeates

0:56

their entire investing philosophy, from

0:58

finding quality businesses to finding quality

1:01

business cultures and quality management. But

1:03

it goes even deeper. They eventually sought

1:06

out to look for businesses of

1:08

such a quality that attempted to

1:10

maximize their relationships with their customers

1:12

through returning excess profits to their

1:14

loyal users. This is

1:16

why they prized the Scale Economy Shared Business

1:18

Model. But when

1:20

you continue to peel back the layers, quality

1:22

surrounded more than just purely the investing process.

1:25

The way the partnership was carefully crafted was

1:27

a direct result of their commitment to quality.

1:30

The partnership was created to deliver returns to the

1:32

partners, and not as a vehicle to

1:34

collect fees. While this may

1:36

seem trivial to the average person, listeners

1:38

of this show will realize how rare it is

1:40

for a financial institution to act this way. One

1:43

of the biggest insights I had while researching

1:45

this episode was in regards to a simple

1:48

set of words they use to better understand

1:50

concepts like risk management, certainty, outcome,

1:53

downsizing, and conviction. This

1:55

was a mental model that they called their cone

1:57

of uncertainty. I know you will enjoy it.

2:00

learning more about how investors can use this

2:02

concept to improve their decision making, decrease

2:04

risk, manage conviction, aid

2:07

in concentration, and a number of other benefits.

2:09

But this is just scratching the surface of what I'll

2:11

discuss on today's episode. You'll also learn

2:13

about the rare and unconventional way that Nomad

2:16

wanted to be evaluated by their partners, why

2:18

they considered inactivity as its own kind of

2:20

activity, why a deep understanding

2:22

of a business earlier than the market is

2:24

so beneficial and allows you to have outsized

2:27

positions that can continue growing at market beating

2:29

returns, why your next

2:31

best investing opportunity might already be in

2:33

your portfolio, specific questions to

2:35

ask to help you utilize destination analysis,

2:38

and the four most powerful mistakes that Nick

2:40

and Zach observed in the markets. If

2:43

you want to learn the investing philosophies and

2:45

strategies of two great investment thinkers with an

2:47

outstanding track record, you won't want to miss

2:49

this. Now, let's get

2:51

right into this week's episode. Celebrating 10

2:54

years and more than 150 million

2:56

downloads, you're listening to the Investors

3:02

Podcast Network. Since 2014, we studied

3:04

the financial markets and read the

3:07

books that influenced self-made billionaires the

3:09

most. We keep you informed and

3:11

prepared for the unexpected. Now,

3:14

for your host, Kyle Greve. Welcome

3:26

to the Investors Podcast. I'm your host, Kyle

3:28

Greve, and today, I have no guests. So

3:30

there's one set of fund letters that has

3:32

significantly impacted many great investors, such as Monish

3:35

Pabrai and Bill Miller, and that is a

3:37

Nomad Investment Partnership letters. I've read

3:39

them and I've learned a lot of important lessons. But

3:41

when I heard that there was a book written in

3:43

the similar vein to Warren Buffett's Ground Rules, I was

3:45

very, very excited. These compilation style books

3:48

are so helpful because they get down to

3:50

the essence of the primary topics that a

3:52

set of investing letters is really talking about.

3:54

Now, The Rational Cloner compiled Nick and Zach's

3:56

letters and wrote the book Nick and Zach's

3:58

Adventures in Capitalism. The book has

4:01

40 chapters in Part 1 on important

4:03

investing concepts. Then, in Part 2,

4:05

it discusses some case studies of the businesses

4:07

that Nick and Zach owned. In

4:09

today's episode, we'll be covering some of the concepts from Part

4:11

1 of the book. I've chosen

4:13

just a few of the chapters with the most powerful lessons

4:15

that I want to share with you. But

4:18

before we get into the specifics, let's have a

4:20

look at Nomad's ground rules. They

4:22

named about 6 of them here, okay? So

4:24

the first one is that we are investing

4:26

for the long term in modestly valued firms

4:28

run by management teams who can be making

4:30

decisions the fruits of which may not be apparent

4:32

for several years to come. Number

4:34

2, the near term results are likely to

4:36

be as bad as they are good. But

4:39

we are confident that in the long run, they

4:41

will prove satisfactory. Number 3, Nomad's

4:44

competitive advantage over its peers will come from

4:46

the capital allocation skills of your manager, if

4:48

any, and the patience of our

4:50

investor base. Number 4, only

4:53

by looking further out than the short term crowd

4:55

can we expect to beat Number

4:57

5, it is for this reason

5:00

we named Nomad an investment partnership and not

5:02

a fund. The relationship we

5:04

seek is quite different. And

5:06

number 6, one of Nomad's key advantages

5:08

will be the aggregate patience of its

5:10

investor base. Now, there's one

5:12

significant theme here that really jumps out to me

5:14

in all of these points. And

5:16

that's the concept of time. Namely, Nomad

5:19

looked for long term opportunities and

5:21

investors who were willing to seek

5:24

long term returns while being willing to

5:26

accept short term volatility that was inherent

5:28

to their strategy. I think

5:30

they did a wonderful job of creating the partnership

5:32

to align incentives in a way that was beneficial

5:35

for both themselves and their partners. Now

5:37

let's have a look at their partnership structure. Nick

5:39

and Zach were not in the business

5:42

of collecting fees by increasing assets under

5:44

management. They did charge a tiny

5:46

management fee, which was just enough to cover costs,

5:48

which they kept quite low. Then

5:51

they would take a cut of profits above a 6% hurdle

5:53

rate, which was what Buffett did in

5:55

the Buffett partnerships. An interesting

5:57

wrinkle that they did to make things even harder

5:59

for them. to earn was in the event that

6:01

performance fell short for multiple years. To

6:04

deal with this, they set quote, aside their

6:06

performance fees for a few years, and if they

6:08

fell short of the 6% hurdle, they would

6:10

refund a portion of the previously earned fees

6:12

to their investors. Now, the goal

6:14

of the Nomad Investment Partnership was very

6:16

simple, and it was to

6:19

generate large, absolute returns. Note

6:21

how I didn't say that they wanted to beat

6:23

the index. The index had no

6:25

place in their investing and mattered very little to them,

6:27

which is very contrary to the majority of funds out

6:30

there. We'll touch more on this later. The

6:32

ultimate goal was to turn a dollar into $10. And

6:35

they wanted to do it utilizing Charlie Munger's sit-on-your-butt

6:37

style of investing by buying just a few stocks

6:39

that would be worth holding onto for a multi-year

6:41

time period. And they crushed it

6:43

on this goal. The partnership ran from 2001 until

6:45

the end of 2013. During

6:48

that time, they had annualized returns of

6:50

over 18% after fees. If

6:52

you'd invested a dollar in 2001 before fees when

6:55

the partnership closed, you'd have $10. During

6:58

the same time, the MSCI World Index returned just

7:00

6.5% per annum. Another

7:03

interesting point about the business fee structure was

7:05

how Nick and Zach fought about the management

7:07

fee. They said that they would

7:09

take a salary cut to run Nomad, and

7:11

the plan was that as Nomad scaled up,

7:14

the management fee would decline as a percentage of

7:16

assets. Therefore, all investors would

7:18

share in the scale economics of the fund's

7:20

continued growth and success. Now

7:22

let's get into some details about the types of investment that

7:24

Nick and Zach were looking for. It's

7:27

worth noting here that Nomad's investing strategy

7:29

became much more refined over time. Kind

7:32

of like Buffett, although Buffett ended up taking

7:34

probably a few more years to come to

7:36

the high-quality camp compared to Nick and Zach.

7:39

In the beginning, they looked for a business

7:41

with the three following characteristics. 1.

7:43

It should be currently valued at 50% of its

7:46

intrinsic value. 2. It

7:48

should be run by owner-oriented management. 3.

7:51

It should be employing a long-term capital allocation

7:53

strategy with shareholder wealth as the focus point.

7:56

Now, even as they evolved, I think they still

7:58

stayed true to these principles. But

8:01

I think they started adding additional emphasis

8:03

on a fourth characteristic, which was the

8:05

search for a business that expressed scale

8:07

economics shared. In the early

8:09

days of Nomad, you can find all sorts of

8:11

cigar butts that they invested in that didn't really

8:13

have a lot of the concepts

8:15

of quality that you would traditionally think of. But

8:18

interestingly, here's how they viewed the simple math

8:20

of their holdings according to the 50% rule

8:23

of intrinsic value. I want to

8:25

go over a little bit of the math here of

8:28

why they wanted these businesses' price to

8:30

be trading at 50% of intrinsic

8:32

value. So they figured that the business they bought

8:34

for a 50% discount would grow its

8:36

intrinsic value at approximately 10% per annum.

8:40

Now the effect of this over five years would

8:42

be that the $1 of value would turn into

8:44

approximately $1.62 of value. However,

8:46

since they were buying at a 50% discount, they reaped

8:48

the returns from $0.50 to $1.62. Now

8:53

this assumes that the company's price would eventually

8:55

align with its value. And if it

8:57

did, you would get a compounded annual growth rate of around 26%.

9:00

But in reality, they knew that they would make

9:03

mistakes. If all their holdings were flat over that

9:05

five-year span, they assumed that their compounded annual growth

9:07

would amount to about 13%. But

9:10

this is where the beauty of compounding really comes into

9:12

play. So God and Bade had

9:14

a really good example of this asymmetry of

9:17

compounding in his interview with Clay on TIP

9:19

5A3. Let's just say

9:21

that you start with two investments. And

9:23

let's say we have $20,000 to split between the two. One

9:27

compounds at 26% annually and

9:29

one compounds at negative 26% annually. Now

9:32

intuition would tell me or other

9:35

people probably who don't understand compounding that these really just

9:37

cancel each other out and that we end up with

9:39

$20,000, the same amount that we

9:41

invested from the beginning. But that's

9:44

wrong because compounding is asymmetric. The

9:46

winner turns into about $100,000 and the loser turns into $500. Add

9:51

these up and you still get a compounded annual growth rate of 18%. Now

9:55

another important exercise they did was to track the

9:57

difference in price and intrinsic value for the portfolio

9:59

as a whole. This was their

10:01

attempt to portray the price and value differences in

10:03

the businesses they owned in the portfolio

10:05

so that their partners best understood what they were

10:07

trying to do. Another investing

10:09

topic I find fascinating is how outperformers

10:12

think about measuring and explaining their performance.

10:15

Warren Buffett said any financial professional should be

10:17

willing to state unequivocally what he is going

10:19

to attempt to accomplish and how he proposes

10:21

to measure the extent to which he gets

10:24

the job done. I think they

10:26

did a very good job of explaining this in

10:28

their fund letters by saying that they wanted to

10:30

be measured on a compounded basis and on a

10:32

multi-year total basis. They also

10:34

added that it was likely they would underperform

10:36

the market at times and overperform the market

10:39

at other times. They would be more likely

10:41

to overperform in down markets and underperform in

10:43

up markets, kind of similar to what Warren

10:45

Buffett proposed to his shareholders in the Buffett

10:47

Partnerships. Now, a simple way

10:49

to measure their performance would be in rolling

10:52

five-year increments. They believe that this time

10:54

span gave more of an accurate view of performance

10:56

rather than trying to constrict that time horizon and

10:58

make it shorter and shorter. It's also

11:00

worth noting that they did not bother trying to

11:02

beat the index. They knew that

11:04

trying to beat the index would result in short-term thinking,

11:06

which was something they were not interested in doing. To

11:09

justify these long-term holdings, it usually

11:12

means you need businesses with long-term

11:14

characteristics. And those are the

11:16

types of businesses where inactivity is the best course

11:18

of action. It is important to

11:20

note that it did require some time for them

11:22

to arrive at the conclusion that holding high-quality businesses

11:24

was the direction that they wanted to go in.

11:27

For instance, one of their smaller holdings from 2004 was Union

11:29

Cement, which was the largest

11:32

Filipino cement company trading at about a quarter

11:34

of the replacement cost of its assets. So

11:36

it was dirt cheap. They wanted to continue

11:38

building their position as a price cratered. Shares

11:41

crashed from $0.30 down to $0.01 to

11:43

$0.02, and they began acquiring it

11:45

around the bottom here. But even though

11:47

this was a small position, it was taken private at $0.10 a

11:50

share and they ended up making a very, very good profit. But

11:53

this seems closer to a cigar butt than

11:55

a quality compounder. And as

11:57

time went on and they drifted towards

11:59

inactivity, they realized that inactivity only pairs

12:01

with quality businesses. They said no investor

12:03

would argue that inactivity should be paired

12:05

with low quality businesses. Throughout

12:07

different renditions of their letters, they discuss

12:09

the problems associated with inaction in the

12:12

investing industry. Specifically, they discuss

12:14

why fund managers are forced into action

12:16

because they are collecting fees and feel

12:18

required to be overactive. But

12:21

as they also pointed out, inaction is

12:23

itself an action. So, any

12:25

investor who chooses to do nothing is still

12:27

looking after the fiduciary duties of their partners.

12:30

To emphasize the importance of this

12:32

concept, they said, Our portfolio inaction

12:34

continues. And we are delighted

12:36

to report that purchase and sale transactions

12:38

have grinded to a halt. Our

12:41

expectation is that this is a considerable source

12:43

of value added. Now, Buffett

12:45

and Munger have been touting the benefits of

12:47

inactivity for decades, but very few people seem

12:49

to listen. Nick and Zach agree

12:51

and think that the primary reason for this

12:53

is that inactivity requires patience. Since

12:56

inactivity is not usually a feature of

12:58

success in other fields, it

13:00

is rarely imitated. Additionally, they

13:02

say that inactivity is the enemy of high

13:04

fees. Now, they outlined four

13:06

reasons why they drifted towards inactivity. The

13:09

first reason, they don't know that much, and it's

13:11

easier to have an opinion on many fewer stocks.

13:14

The second reason was that outstanding cultures

13:16

are more powerful than they had originally

13:18

realized and they wanted to hold businesses

13:20

that had these incredible cultures. The

13:23

third reason was that inactivity reduced the reinvestment

13:25

risk when you're fiddling around with names that

13:27

maybe you don't understand as well as what

13:30

you already own. And the

13:32

last reason was that many of the great businesses

13:34

during the time that they wrote this were on

13:36

sale. So this section was written in 2009 during

13:38

the great financial crisis. During this time,

13:40

the S&P 500 went from a high of 1,565 in 2007 down to a low of 676 in

13:46

2009. So if you

13:48

look at some of the biggest holdings that they're best

13:50

known for, which was Amazon, Costco, and Berkshire Hathaway, I

13:52

just want to go over some of the drawdowns that

13:54

they went through during this time. So

13:56

Amazon had a 64% drawdown in 2009. Cost

14:00

got a 47% drawdown in 2009 and Berkshire Hathaway had a 51%

14:02

drawdown in 2009 as well. So

14:08

the fact that they were already very familiar

14:10

with these businesses meant that they could just

14:12

vacuum up shares at very, very attractive prices.

14:15

Now I'm not really sure what their cost basis

14:17

was on these names. I'm not

14:19

sure how long they were buying them for. For

14:22

all I know, they could still be buying them today. But

14:25

here are the compound annual returns from these

14:27

bottoms during the great financial crisis. So

14:29

Amazon has a 31% compound annual

14:31

growth rate from its bottom in 2008.

14:34

Costco, a 23% compound annual growth rate from

14:36

its bottom in 2009. And

14:39

Berkshire Hathaway, a 14% compound annual growth rate from

14:41

its bottom in 2009. During

14:44

the great financial crisis, they wrote, it

14:46

may not feel like it, but for long-term investors, this

14:48

is the best of the times, not

14:50

the worst. Take art and

14:52

look to the horizon. I just

14:54

love the saying because it just really gets you

14:57

focused on looking into the future and not dwelling

14:59

on the negatives in the present. Now

15:01

back to the right business models to be an inactive

15:03

investor. They highlight two wonderful

15:05

businesses they owned in Costco and Amazon that

15:08

had just three of the following attributes. They

15:10

were founder-led, they had great cultures, and

15:12

they had a culture that was geared towards cost savings.

15:15

These two businesses definitely had these qualities in

15:17

large amounts. While Costco and

15:19

Google are still great businesses today, they're no longer

15:22

founder-led. But I still think they have

15:24

some of the great characteristics of a wonderful business. Let's

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americanexpress.com Alright,

17:51

back to the show. Now the

17:53

next concept I want to cover is the investment models Nick

17:56

and Zach searched for. As early as

17:58

2004, it looked like they were beginning to understand. and

18:00

the power of a business model they really liked, which

18:03

they named Scale Economics Shared. You

18:05

probably have a good idea of what scale economies are, but

18:08

if you need a quick refresher, it's when

18:10

a business scales and unit costs decrease. But

18:13

here's what Nick and Zach said differentiated Scale

18:16

Economics Shared. As a firm

18:18

grows in size, scale savings are given back

18:20

to the customer in the form of lower

18:22

prices. The customer then reciprocates

18:24

by purchasing more goods, which provides greater

18:26

scale for the retailer who passes on

18:28

the new savings as well. Scale

18:31

Economy Shared has a following flywheel characteristics.

18:34

Here's how sleep outlined it. Increased

18:36

revenue causes scaled savings.

18:39

Scaled savings creates lower prices that they can

18:41

charge to customers and lower prices

18:43

that customers have to pay makes them want to shop there

18:45

more, which therefore increases revenue and on

18:47

and on you go. In my

18:49

co-host William Green's great book, Richard Weiser Happier,

18:52

he writes, "'Once sleep in

18:54

Zaccaria understood the magic of this one business

18:56

model, they made it their overriding focus of

18:58

their fund. The attraction of cigar butts

19:00

waned, and they concentrated instead on

19:02

a handful of companies that shared their economies

19:04

of scale with customers. They

19:06

were acutely aware of how little in life we ever

19:09

truly know, but they knew that they

19:11

had uncovered a deep truth." As William

19:13

pointed out, they most definitely made this business model the

19:15

focus of their fund. In 2009, they

19:17

noted that companies in the portfolio with

19:19

the Scale Economics Shared were the following

19:21

names, Carpet Right, Costco,

19:24

Berkshire Hathaway, Amazon, and AirAsia.

19:27

These five businesses combined constituted about 60%

19:29

of the partnership. The

19:32

last point on Scale Economics Shared I'd Like to

19:34

Share was an insight into the investing analysis side

19:36

of things. They noted that when

19:38

interviewing management, they would often ask a very

19:40

unconventional question. That question was,

19:42

what a manager would do with a windfall

19:44

in profits. They came up with a few

19:46

different use cases for windfall profits. One

19:49

was to just reinvest into the business, two

19:51

was a return cash back to shareholders in the forms

19:53

of dividends or share buybacks, and three

19:55

was to give it back to customers. They

19:58

noted that barely anybody focused on the business. point

20:00

number three. But Costco was a

20:02

business that did focus on point number three. If

20:05

they could find a business that is giving

20:07

back profits to customers, they knew that they

20:09

had found themselves a real winner that fit

20:11

very, very well into the scale economies shared.

20:14

They pointed out that they thought the

20:16

reason barely any business was doing this

20:18

was because it just wouldn't bode that

20:20

well on Wall Street. But businesses like

20:23

Costco were conducting its business to raise

20:25

a probability of long-term success, consistently sharing

20:27

excess profits with its customers and

20:29

just not really bothering with caring what Wall

20:31

Street thought. I love this

20:33

insight. And I can't say I've researched businesses that

20:35

are explicit about giving back profits to customers. A

20:38

business that my co-host Clay and I recently discussed

20:41

was Old Dominion Freightline, which I think

20:43

has a degree of scaled economies embedded into it. But

20:45

they aren't sharing the excess profits directly

20:48

with customers. Instead, they use these excess

20:50

profits to provide a superior service to

20:52

competitors without a reduction in price. So

20:54

one chapter I really enjoyed reading was

20:57

about the competitive advantages specific to the

20:59

Nomad partnership compared to other funds or

21:01

partnerships. So they noted three

21:03

advantages in investing that Bill Miller has

21:05

previously outlined. One is the analytical edge,

21:07

two is the informational edge, and three

21:09

is a psychological edge. Now,

21:11

while they agreed with this premise, they actually

21:13

added an additional edge that was very specific

21:16

to their partnership. And this was

21:18

the patience of their investor base. Additionally,

21:20

they believe that they had an edge in

21:22

the analytical and psychological departments. This

21:24

is a really exciting insight because you rarely

21:27

read about how a fund can utilize the

21:29

patience of its investor base to generate excess

21:31

returns. And it's kind of

21:33

easy to see why. With so many investors

21:35

looking for immediate returns, the Drought Awards instant

21:37

gratification is very, very strong. And

21:39

because of this, a fund manager might have a

21:41

hard time justifying purchasing a business at a cheap

21:43

price that may stay cheap for an extended period

21:45

of time. Most sophisticated investors realized

21:48

that a great business trading for a cheap

21:50

price actually de-risks the investment. But the average

21:52

investor has a very hard time coming to

21:54

grips with this statement. So fund managers basically

21:56

have to try and ride the momentum of

21:58

stocks moving up in price. even

22:00

if the price isn't necessarily attractive. Another

22:03

advantage that Nomad had due to the patience of their

22:05

shareholder base was the ability to hold cash. It's

22:08

been pointed out that cash doesn't earn a

22:10

return and therefore being fully invested is a

22:12

rational decision. While I mostly agree

22:15

with this, the right investor with a large cash

22:17

balance or the ability to call cash in at

22:19

a moment's notice is very powerful if you have

22:21

the proper fund structure. Nomad had

22:23

the former structure and their shareholders knew that cash

22:26

was sitting on the sidelines waiting to be put

22:28

to good use rather than spent frivolously on whatever

22:30

stocks were currently in favor in the market. They

22:33

also noted that Nomad was a partnership. They

22:36

named it a partnership very intentionally because

22:38

they wanted investors to understand the relationship

22:40

between the investors and the managers

22:43

was to be thought of as a genuine

22:45

relationship where each party succeeds and fails together.

22:47

Now if I were to invest my own money

22:49

with somebody else, I would demand that they take

22:51

part in both the upside and the downside, which

22:53

very few fund managers tend to do. Now

22:56

I want to take some time here to discuss a

22:58

concept that I find fascinating that Nick and Zach mention

23:00

often in the book, which is risk. Much

23:03

of what they wrote makes me really think of how

23:05

it works. So Nick and Zach

23:07

right here, what you are trying to do as

23:09

an investor is exploit the fact that fewer things

23:11

will happen than can happen. That

23:13

is exactly what we are trying to do. We

23:15

spend a considerable portion of our waking hours

23:18

thinking about how company behavior can make the

23:20

future more predictable and lower the

23:22

risk of the investment. Those

23:24

obsession with sharing scale benefits with the customer

23:26

make that company's future much more predictable and

23:28

less risky than the average business. And

23:31

that is why it is our largest holding. Our

23:34

smaller holdings are less predictable, but in

23:36

certain circumstances could do much better as

23:38

an investment. We are just not

23:40

sure, they will, as their cone of

23:42

uncertainty has a much greater radius than

23:44

Costco. Now there are many

23:46

concepts from this short passage to go over in

23:48

more depth. The first part, where you are trying

23:50

to exploit the fact that few things will happen

23:53

than can happen sounds exactly like Mark's. Howard

23:55

Mark said, risk means more things can happen

23:58

than will happen. It's a

24:00

simple statement, but it's very true. So you

24:02

have to appreciate the fact that under any set

24:04

of circumstances, a variety of outcomes are possible and

24:06

you should always allow for the vagaries of the

24:09

future. Now I really liked how

24:11

Nick and Zach weaved this concept of risk

24:13

into certainty. They said that they spent a

24:15

lot of time trying to find out if

24:17

a business was doing what they thought was

24:19

necessary to increase the probability of reaching a

24:21

specific destination. I enjoy how they

24:23

looped it into this concept that they called their cone

24:25

of uncertainty. And once they found

24:27

a business that was executing at a high level

24:30

for extended periods, they felt that this cone

24:32

of uncertainty would get smaller and smaller, which resulted

24:34

in two main things. One, a

24:36

de-risking of the investment and two, an increased

24:38

probability of reaching a good destination in the

24:40

future. And this is why

24:42

I think eventually they just settled on three

24:44

primary investments, which were Costco, Amazon and Berkshire

24:46

Hathaway. My guess is that those three

24:49

businesses had the smallest cones of uncertainty out of anything that

24:51

they own in the portfolio. Because

24:53

of that, they allowed the positions to continue

24:55

increasing in size, eventually making up a very

24:57

large portion of the portfolio. Now,

24:59

this is one concept that I'm starting to

25:02

really appreciate as I spend more and more

25:04

time researching other great investors. One

25:06

of my favorite recent examples was from my

25:08

co-host William Green's interview with Bruce Berkowitz in

25:11

Richard Weiser Happier 41. In

25:13

that episode, Bruce Berkowitz discussed his conviction in

25:15

St. Joe. St. Joe makes up

25:18

an eye-popping 82% of

25:20

Bruce's fair home funds. But it hasn't

25:22

always been this way. It started out at a 3%

25:24

position and grew for a variety of reasons. And

25:27

he's allowed it to grow due to his familiarity with the

25:29

business. It's pretty clear that once

25:31

you understand a business at such a higher

25:33

level than everyone else, then allowing it to

25:35

grow is probably a very good strategy. I

25:37

will say that getting to this point of understanding

25:39

will require a lot of work and time. I

25:42

don't think you can understand St. Joe like Bruce

25:44

Berkowitz does in a very short period of time,

25:46

even if you were to spend every waking moment

25:48

thinking about it. The idea has to

25:50

play out and you need to continue learning

25:53

more, looking at different angles and coming up

25:55

with views on the business that aren't widely

25:57

shared by other investors. It's

25:59

evident today that Amazon and Costco are wonderful

26:01

businesses. But I think Nick and

26:03

Zach realized how wonderful they were a lot earlier

26:05

than other investors. And they had

26:07

the patience to allow the thesis to play out

26:09

while making the decision to not remove these positions

26:11

from their portfolio just because they thought they might've

26:14

become optically expensive. The final part

26:16

of the passage I wanna discuss regarding risk was

26:18

portfolio management. While Nick and Zach

26:20

knew that they might have some positions in

26:22

the portfolio that would outperform Costco, for instance,

26:25

they were fine keeping the position size

26:27

small. Their largest positions were

26:29

the ones with the highest certainty for

26:31

success and the lowest possibility of losing

26:33

money. While I think many

26:35

investors are good at increasing position sizes

26:38

for businesses with high upside, I think

26:40

that many investors, including myself, have

26:42

a harder time dealing with the risk portion. I

26:44

think using probabilistic thinking is the best way to

26:46

display this. Let's say that we have

26:49

two investments in our portfolio. One

26:51

has a 70% chance of going up $100 and

26:54

a 30% chance of going down $100. So

26:57

the total expected value of this investment is $40. The

27:00

second one is a 30% chance of going up $200 and

27:03

a 70% chance of going down $200. The

27:05

total expected value of this investment is negative $80. It's

27:08

easy to see the allure of ignoring the risk

27:11

portion of this equation. One investment

27:13

can make $100 and the other investment can

27:15

make $200. Now that's

27:17

great, but if we ignore risk, then we fail

27:19

to see that the investment where we make $200

27:21

is actually much, much riskier than the one

27:23

where we make $100. Now,

27:25

I don't advocate putting money into investments with

27:27

negative expected value, but let's just say, for

27:29

example, that we have both of these investments

27:31

in a portfolio. Now, let's say

27:33

we become more and more comfortable with one of these

27:35

businesses, the first example, and continue to see them executing

27:38

at a very high level. Because

27:40

they're starting to de-risk and because we're starting

27:42

to understand the business better and we're starting

27:44

to see they're thinking long-term, we

27:46

see that the chances, the probability, of

27:49

losing money is actually coming down. Maybe the chance of losing

27:51

$100 goes from the 30% chance all

27:54

the way down to 10%. At this

27:56

point, the expected value of the investment is so high

27:58

that it makes a lot of sense substantial amount of

28:00

money into the idea. And Warren Buffett

28:03

would agree. He said, So I

28:05

would say for anyone working with normal capital who

28:07

really knows the businesses they have gotten into, six

28:09

is plenty, and I would probably put half of

28:11

it into what I like best. Now

28:13

speaking of your best loved idea, Nick and Zach

28:15

had some interesting takes on the one bias they

28:17

continually sought to fight to help them optimize their

28:19

decision making. The bias that they tried

28:22

to fight against was commitment bias. So

28:24

they said that in investing, commitment bias

28:26

occurs when we publicly disclose our positions,

28:28

which most definitely affects our objectivity towards

28:30

the position. This is

28:32

a really interesting notion in today's age

28:35

where sharing information, ideas, and

28:37

investments has become pretty widespread. People

28:39

enjoy sharing ideas. And I don't think sharing

28:41

an idea has some sort of harmful ulterior

28:43

motive. I think people like sharing for

28:45

a variety of reasons. It helps

28:48

you become part of a community of other

28:50

investors who share the investment that

28:52

you have. It also helps you

28:54

spread awareness about maybe investments that are undiscovered

28:57

by larger swaths of people. It

28:59

allows you to find other investors who might already

29:01

be invested in the name and who can share

29:03

information that maybe you can't easily come across. And

29:05

lastly, it just opens up conversations on the business

29:08

and people love talking about the businesses that they

29:10

own. And that's all well

29:12

and good, but the problem can arise when

29:14

you fail to get any conflicting

29:16

information that doesn't confirm what you already

29:19

know. Social media can be a

29:21

pretty brutal space. But often, people who

29:23

follow you on something like Twitter aren't following

29:25

you because they want to argue about stocks.

29:28

They follow you because they want ideas, and generally,

29:30

those are long ideas. So sharing

29:32

ideas on Twitter usually means you get other people

29:34

joining you in the bullishness that you already have.

29:37

Here's what Munger said on this exact subject

29:39

in the lens of post-secondary educational institutions.

29:42

If you make public disclosure of your conclusions, you're

29:44

pounding into your own head. Many

29:47

of these students that are screaming at us, they aren't convincing

29:49

us, but they are forming mental

29:51

chains for themselves. Because what they are shouting

29:53

out, they are pounding in. And

29:55

I think that educational institutions that create a climate

29:57

where too much of that goes on, are... in

30:00

a fundamental sense, they are irresponsible institutions.

30:03

Now the key term here is what they are shouting out,

30:05

they are pounding in. Here's how Nomad

30:07

thought finder managers should approach the problem of

30:09

commitment bias. Our thinking is

30:12

that fund managers should have absolute

30:14

conviction on the philosophy and methodology

30:16

of their investment principles, providing of

30:18

course that those principles reflect reality.

30:20

But they should be circumspect about expressing

30:23

these tenets as they relate to individual

30:25

stocks. Evangelism is

30:27

not healthy. The reason

30:29

is that whilst fund managers have it in their

30:31

power to control the way they think, they

30:34

are unable to control how their companies

30:36

behave. Businesses evolve, companies

30:38

make mistakes, business managers change

30:40

their minds, share prices depart

30:42

from reality. The investment

30:44

manager can control none of these factors but

30:47

needs to assess objectively each one for the

30:49

risk of misc analysis. Now

30:51

the whole point here is just that you

30:53

must be willing to combat commitment bias by

30:55

allowing yourself to walk away from an idea.

30:58

When you share an idea publicly, it can be harder

31:00

to walk away from as it becomes embedded into

31:02

your identity. I think it's intelligent never to

31:04

let this happen. Wonderful businesses die all the

31:06

time. Just look at some of the darling stocks

31:08

that were part of the nifty 50 index from

31:11

the 60s and 70s. You got

31:13

Eastman Kodak, you got Sears, you got Xerox. These

31:15

were all wonderful businesses that at one time were

31:17

thought to be so good that no price was

31:19

too expensive to pay for them. Well,

31:21

that didn't turn out very well. And the

31:23

investors who committed to those ideas would have been

31:25

crushed by the market as the fundamentals of those

31:27

businesses shifted to the downside. So if

31:29

you share ideas, permit yourself to change your mind

31:32

and never allow an idea to become part of

31:34

your identity. Otherwise, I think you risk biases like

31:36

commitment bias to really expose you to excessive amounts

31:38

of risk. Let's take a quick break

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back to the show. Now let's transition

35:16

here and chat briefly about how Nomad

35:18

approaches position sizing and diversification. Like

35:20

many high-performing money managers, they were concentrated in

35:22

just a few positions. The

35:25

Rational Cloner noted they averaged around 10

35:27

positions. But

35:30

if you go back to June 2009, they had about 20 positions. But

35:35

if you looked at 10 of those positions, they were

35:38

80% of the portfolio. And

35:42

during that time, one position made up an astounding 30% of the

35:44

portfolio. The

35:47

book's author and I agree that the thought process

35:49

through these levels of concentration made a lot of

35:51

sense for Nomad. Because they

35:53

spent so much time thinking about just a few

35:55

ideas, it made sense to really concentrate their assets

35:57

on the ideas that they had the highest conviction

35:59

in. Doing this would also

36:01

reduce risk and not increase it as

36:04

standard investing dogma would suggest. Only

36:06

Nick and Zach were running the firm, not an army

36:08

of helpers. So understanding many ideas

36:10

in depth was just not possible. So

36:13

I think they made the rational choice to concentrate their

36:15

assets on positions that they had the highest certainty on.

36:18

They had a very, very good quote on diversification

36:20

and parenting that I thought was very insightful. Parents

36:23

will understand when I say when children are

36:25

born, they seem to bring their own love with them. However,

36:28

stocks are not like children.

36:31

The more stocks you own, the less you

36:33

care about each one individually. Now

36:36

I can personally attest to this on the diversification

36:38

front. The more assets you own,

36:40

the less you care about each one individually. I

36:42

think this is a really good heuristic that can

36:45

really help you decide when it might be time

36:47

to part ways with a position. Throughout the years,

36:49

I've had businesses where getting through earnings call was

36:51

just a slog and I derived very little joy

36:53

from following along with the business. This

36:56

doesn't always have to even do with the stock performance

36:58

going up or down either. Sometimes

37:00

the business fundamentals are just starting to unravel and

37:02

I think using your gut instinct can be an

37:04

intelligent decision. One example from

37:06

2023 was Inmode, a business that I

37:08

think was pretty good but had mediocre

37:10

capital allocators running the show. Now

37:13

I wanted to see something in their annual

37:15

call regarding capital allocation, but I just didn't

37:17

see it. So I part a ways with

37:19

the business and I haven't regretted it since. This

37:21

was a business that compounded my capital very well, but I

37:23

just didn't feel right about the management team. One

37:26

last point I wanted to mention here about concentration is

37:28

that it either works very well or very poorly. And

37:31

if you're a concentrated investor, you better be willing

37:33

to live with volatility because you will experience it

37:36

in very high quantities. So

37:38

if you're the type of investor who can't

37:40

stand seeing your portfolio go down significantly without

37:42

selling holdings, you're much better off

37:44

diversifying because the concentrated approach will probably do

37:47

more harm than good for you. Now

37:49

one theme that comes up often in this

37:51

book is that investing is simple but not

37:53

easy. The rational cloner

37:55

writes that honest, simple, long-term investing

37:57

is unexcited. very

38:00

well with one of Monique's favorite sayings that, you

38:02

will make a very good investor if you enjoy

38:04

watching paint dry. But what is

38:06

it about investing that is unexciting that Nomad was able

38:08

to leverage to outperform the market for all those years?

38:11

There are a few. Nomad gave themselves four

38:13

choices of where they want to invest. They

38:16

could either add to existing holdings, invest

38:18

in new firms, invest in growth businesses,

38:20

or invest in cigar butts. They

38:23

much preferred adding to existing holdings. And

38:25

the reasoning was simple. They thought many

38:27

of the businesses they already held had long growth

38:29

runways. So adding to these businesses would

38:32

be a great choice versus alternatives given

38:34

the depth of their understanding on the businesses that they

38:36

already knew and owned. Secondly, they

38:39

ignored industry dogma. Third, they

38:41

did a lot of homework and they believe

38:43

there was almost no competition for long-term investors

38:45

who are willing to put in a lot

38:47

of research, time, and thinking into an investment.

38:50

And lastly, since they traversed the less traveled road,

38:52

they found themselves surrounded by very, very little

38:54

company. In my investing journey, I find

38:57

that it's getting easier and easier to focus on

38:59

names that I already own. I

39:01

continue to add to current positions,

39:03

averaging up opportunistically. Monish Pabrai

39:05

once used the analogy of a museum for his portfolio

39:07

and I think it's a great one. I'd

39:10

rather continue to highlight what I already own and know

39:12

very well rather than maybe bringing in a new piece

39:14

of art that I might not like very much. This

39:17

strategy again will only work if you're a long-term

39:19

investor. A wonderful business is like a great piece

39:21

of art. It will become more and more valuable

39:23

with age. Another investing insight

39:26

from this chapter on simple but

39:28

not easy was Nomad's emphasis on

39:30

keeping portfolio-wide metrics. Now,

39:32

I think this is a great mental model for

39:34

treating your portfolio as it's kind of its own

39:36

conglomerate business. So Nomad tracked

39:39

a few different things that were portfolio-wide.

39:41

They looked at the weighted average revenue growth,

39:43

which in 2011 was over

39:46

30% per annum, which if you compare that to other

39:48

people's portfolio or the index is going to be at

39:50

a much, much higher growth rate. They

39:52

looked at price-to-value ratio, which basically showed the

39:55

price of their portfolio versus the current value

39:57

they assigned to the total portfolio. So they...

40:00

They would do this as a percentage. They

40:02

would say at this point in time, the

40:04

net asset value is X and the value

40:06

that they saw was Y and then they would

40:08

just divide it. So you would get, I

40:10

remember one point them saying that they had

40:12

a price-to-value ratio of about 60%. So

40:15

that means that they thought that their portfolio

40:17

was obviously very much undervalued by the market.

40:20

And then lastly, they'd like to track return

40:22

on invested capital and they noted that return

40:24

on invested capital was about double in

40:26

the firms that they owned versus their firm's competitors. So

40:29

tracking these kinds of portfolio wide metrics is

40:32

a great way to observe how your portfolio

40:34

is differentiated from the market. Another

40:36

metric that they used on a few individual

40:38

holdings was what they called the robustness ratio.

40:41

The robustness ratio measures how much

40:43

a customer saves versus the amount

40:45

earned by shareholders. Let's give

40:48

an example here. If a customer

40:50

saves $5 and a shareholder earns $5, the

40:52

ratio would be one-to-one. This

40:54

is the ratio that they thought that Geico had. But

40:56

Costco had an insanely high robustness ratio of

40:59

about five-to-one. I think it's

41:01

important here to talk a little bit about

41:03

the genesis of this mental model. It came

41:05

from reading the 2005 Berkshire Hathaway annual report.

41:08

So Nick and Zach Wright, one paragraph stood

41:10

out for us as Warren Buffett referred

41:12

in passing to the division of operating

41:15

and underwriting cost savings at Motor Insure

41:17

Geico. These benefits were

41:19

divided between shareholders, policyholders, and employees

41:21

and the statistics spelt out in

41:24

some detail. This simple

41:26

breakdown struck a chord with our continuing analysis

41:28

of Costco, a significant marathon holding in the

41:30

United States. What is becoming

41:33

clearer in our minds is that one can empirically

41:35

measure the strength of a business franchise through

41:37

such an analysis of the division of benefits,

41:40

what we have come to call its robustness

41:42

ratio. Nick and Zach believe

41:44

that firms with a very high robustness ratio

41:47

actually increase the strength of their moat. When

41:50

looking at the Costco example, it's pretty hard to

41:52

argue the accuracy of this premise. As

41:54

Costco scaled up, they were able to save more

41:56

and more money for their customers. It would have

41:59

been interesting to see if Nomad tracked how Costco's

42:01

robustness ratio grew over time. I wonder

42:03

if they kept it at that 5 to 1 ratio or

42:06

if that number scaled up from a smaller

42:08

robustness ratio when they first started. Additionally,

42:10

it would be interesting to know what the robustness ratio

42:12

is today. While this robustness ratio

42:15

worked very well for Nomad, I

42:17

think that its use case isn't very

42:19

wide-reaching unless you are looking specifically for

42:22

scale economy shared type businesses. If

42:24

you are looking for them, then you probably should

42:26

be learning about this number and probably get a

42:28

very good view of whether a company is improving

42:30

its moat by using the robustness ratio. If

42:33

a business continues to save its customers more

42:35

and more money, its relationship with its customers

42:37

will only improve. And that's a very, very

42:39

strong competitive advantage to have. Now,

42:42

if you are looking to understand the robustness ratio

42:44

a little more, Nomad gave a few interesting tidbits

42:46

of information. It makes sense

42:48

for the early development of a firm

42:50

to reward customers disproportionately to get more

42:53

referrals and repeat business. Therefore,

42:55

they thought that newer businesses should

42:57

have a higher robustness ratio. Now,

42:59

as the same business started to

43:02

evolve and get a little more

43:04

mature, the proportion of the robustness

43:06

ratio going to the customer

43:08

could decrease and going to the shareholder could

43:10

increase. But it's very important

43:12

that you didn't take too much of

43:14

a proportion going to shareholders because if you

43:16

did that, it could obviously have negative effects

43:19

on the relationship that a business has with

43:21

its customers. And if a customer's

43:23

relationship with a business starts getting weaker, that's

43:25

probably going to erode the business's moat. Now,

43:27

the problem is that capital markets want increased

43:29

profits. That was what everyone's looking for. So

43:32

businesses are going to be tempted to lower

43:34

their robustness ratio to appease shareholders and increase

43:36

the amount of earnings that they can show

43:38

on their income statement. Now, I think

43:40

a really good example of this is in some of the

43:42

ride sharing businesses. Many of these

43:44

businesses were giving massive subsidies to acquire

43:47

new users. This helped

43:49

build relationships with customers optically. However,

43:52

once these subsidies were removed, the actual

43:54

stickiness of the company-customer relationship was revealed

43:56

and it was very, very weak. The

43:59

other problem with... giving too much back to the

44:01

customer is that some businesses operate

44:03

at losses for many years while trying to

44:05

grow revenue and then plan on using some

44:08

sort of operating leverage in the future to

44:10

help generate profits. While this looks

44:12

good on paper, it's much harder to accomplish

44:14

in reality. This is why I personally prefer

44:16

to buy businesses that have already solved the

44:18

profitability equation. It doesn't require me

44:20

to take a leap of faith for the investment

44:23

to work out. Now, I did

44:25

want to mention here Amazon. I realized that Bill

44:27

Miller and Nick and Zack

44:29

were very early with Amazon and they

44:31

understood the business far earlier than everyone,

44:33

even when Amazon was a loss

44:36

making company. If you take that approach

44:38

to investing and never looking at businesses that aren't profitable,

44:40

you're going to miss out on a business like Amazon.

44:42

And to that, I say, yeah, that's perfectly fine. I'm

44:44

going to miss tons of investments. I'm perfectly fine with

44:46

that. I'd rather invest in a company

44:48

that I understand very well. If I was looking at

44:51

a business and I thought I understood it super well

44:53

and I understood the future operating leverage of the business,

44:55

then perhaps I would change my mind and look at

44:57

a loss making business. But for now, I like

45:00

the strategy that I'm running. And I think that many

45:02

other great investors, I know Chris Mayer is very similar

45:04

in that he just looks at profitable businesses because he

45:06

doesn't want to have to guess if

45:08

the business is going to be profitable in the future. Now,

45:10

the point here about the robustness ratio, I think

45:13

ties in surprisingly well with the next chapter I

45:15

want to talk about, which is incentives. If

45:17

a business is trying to draw customers in

45:19

with reduced prices to get them to also

45:22

buy products or services at regular prices, the

45:24

incentives are just misaligned. This

45:27

behavior incentivizes the customer to shop around for

45:29

the best deal, not to stay loyal. And

45:31

this is just not a winning

45:33

business strategy. To attract new customers,

45:35

Nomad uses Costco's effective strategy of

45:37

giving everyday discounts that don't fluctuate.

45:40

In the incentive chapter, they discuss two

45:42

overarching aspects. One, what incentives

45:44

do they look for in firms whose stock

45:46

they wish to buy? And two, how will

45:49

they structure Nomad to incentivize Nick and Zach

45:51

to continue creating value for their partners? Now,

45:53

I think I've already discussed point two here enough. So

45:56

we'll focus on the first point. From

45:58

an incentive perspective, what characteristics who

46:00

are Nomad looking for in potential investments.

46:02

They were looking for businesses incentivized to

46:04

raise the probability of a favorable destination.

46:07

We'll be getting into destination analysis here shortly, but

46:10

I really love how they framed the question

46:12

of incentives to weave it into arriving at

46:15

a favorable destination. In Nomad's

46:17

case, since they were focused on scale economies

46:19

shared, they wanted their businesses to

46:21

be incentivized to strengthen the business model. So

46:24

they looked for firms that were incentivizing

46:26

customers to continue doing business with them,

46:28

like Costco. They were also looking

46:30

for firms that could intelligently cut costs

46:32

to prevent competitors from competing due to

46:34

prohibitively expensive unit economics, such as AirAsia.

46:37

And then they were looking for businesses that could

46:40

thrive through economic turmoil. And a great example of

46:42

this is Amazon. Now let's

46:44

chat more about destination analysis, which might be

46:46

one of the book's most important mental models.

46:49

First, what is destination

46:51

analysis? It was basically how

46:54

Nomad analyzed their businesses with a focus on

46:56

the future. Looking at

46:58

a business's future destination helped them best

47:00

understand the company's DNA. So

47:02

some of the questions they would ask included, what

47:05

is the intended destination for this business in 10 to

47:07

20 years? What should management be

47:09

doing today to raise the probability of arriving

47:11

at that destination? What could

47:13

prevent the company from reaching its favorable destination?

47:16

Now I've spent a considerable amount of time

47:18

thinking about a destination analysis. It's a great

47:20

tool to help you think about a business

47:23

using a long-term view. A

47:25

few additional checklist questions I would ask

47:27

that were outlined in Richard Weiser Happier

47:29

were, does the company have a healthy

47:31

internal and external relationships that won't jeopardize

47:33

the destination? Can executives put

47:35

their feet up on a desk and allow business to

47:38

come to them? And is the

47:40

business riding short-term tailwinds that make it look

47:42

better than reality would suggest? The

47:44

fascinating part about destination analysis is that it

47:46

has multiple use cases. Yes, you can use

47:48

it on individual companies to help you identify

47:51

likely long-term winners. However, you

47:53

can also use lessons from destination analysis from

47:55

the past to help you guide your

47:57

decision making in the present and in the future.

48:00

Nick and Zach even mentioned that their performance in

48:02

2007 resulted from some of the mistakes that they

48:04

learned in 2003-2004. This

48:07

scenario makes me think a lot about the

48:10

importance of Seize Candy to Berkshire Hathways' success.

48:13

Seize Candy showed Warren and Charlie the strength

48:15

of a brand moat, which helped them identify

48:17

some of their greatest investments like Coca-Cola and

48:19

Apple. In a world of limited

48:21

information, I think it's really important to use lessons

48:23

that you've already lived through to help

48:25

guide you in the future. You'll make

48:27

fewer errors, you'll find very, very interesting

48:29

connections that other people aren't making, and

48:32

you'll find business models that you're naturally

48:34

attracted to and just understand really, really

48:36

well. Now sticking with the theme

48:38

of Buffett and Munger, Nick and Zach write, Let's

48:41

invert for a moment when we think of our

48:43

investee companies. The firms, which

48:45

we would quite happily own with no

48:47

word from them for a few years,

48:49

are those businesses in which we have

48:51

the highest confidence of reaching a favorable

48:53

destination. They are the firms we think

48:55

we know will work. They are

48:57

also the largest holdings in Nomad. It

49:00

is the less certain businesses about which we

49:02

are more insecure that appear to demand more

49:04

regular attention. The next subject I'd

49:06

like to discuss is mistakes. Nick and

49:09

Zach had a very good self-awareness of the mistakes

49:11

that they were likely to make or

49:13

observed others making or had themselves made in

49:15

the past. They mentioned that

49:17

noticing mistakes is a huge advantage, but is

49:19

so rarely done. They listed

49:21

four mistakes that they found to be most

49:23

powerful. The first one is denial, which

49:26

is basically distorting reality to avoid pain.

49:29

Charlie Munger had a really good example of this

49:31

in the psychology of human misjudgements where he spoke

49:33

about a mother during World War II

49:36

who chose to believe that her

49:38

son was missing at sea rather than dealing

49:40

with the pain of just admitting to herself

49:42

that her son had probably perished on a

49:44

boat during World War II. The

49:47

second one here is anchoring bias, which

49:49

is relying too heavily on information early in

49:51

the decision-making process. The third one

49:53

is drift, and this is how small,

49:55

incremental changes in thinking can

49:57

lead to larger mistakes. And the fourth one

49:59

is Next one here is judging, which is

50:02

excessive condemnation or exalting, which stops rational

50:04

thought. I think this is similar

50:06

to the hating and loving biases that Munger aligned in

50:08

his talk on the psychology of human misjudgments. Now

50:11

these are really potent mistakes to consider

50:13

regularly or you risk making them yourself. And

50:16

I think we will all make these mistakes in

50:18

the future, even if we are aware of them

50:20

to some extent. But I think it's just an

50:22

excellent exercise to actively think about the mistakes you

50:24

could be making, which will hopefully improve your decision

50:26

making. Building bias has been

50:28

a problem for me when adding to current positions.

50:31

I remember I'd be anchored to my initial buy price

50:33

for holding and tell myself that I'd never buy above

50:35

that price if I wanted to add to that position.

50:38

Well, that makes sense for cigar

50:41

but businesses that are unlikely to show much improvement

50:43

in the fundamentals of the business. However,

50:45

a good quality compounder is going to

50:47

continue increasing in intrinsic value. So

50:50

if you anchor yourself to your original cost basis,

50:52

and you do an excellent job of

50:55

picking the right stock, you'll end

50:57

up with a small position that you'll never be

50:59

able to add to, even though the business is

51:01

the exact type of business that you want to

51:03

own a relatively concentrated position in. So

51:05

I have a really good example of this, which was

51:07

with Erytia. So I'd originally bought

51:09

Erytia at the start of COVID-19 back in 2020.

51:12

My first tranche was priced around $16. And

51:15

from there, the stock soared to around $60. I

51:18

was perfectly fine not adding there as it just

51:20

seemed to be well, well above intrinsic value. But

51:24

over time, the stock got less and

51:26

less love from the market as the

51:28

COVID-induced growth rates that had propelled a

51:30

lot of that upward movement in the

51:33

share price and in fundamentals just started

51:35

receding and more normalized growth started showing

51:37

its face. Now I knew that

51:39

I wanted to add to the position, but I

51:42

wanted to add more below $16 and it just

51:44

wasn't looking like that was going to ever happen. But

51:47

in 2023, I realized that the business had gotten much

51:49

better than when I first bought it and

51:52

it was just really silly of me to anchor

51:54

to that original price. And I just

51:56

wanted to share with you a couple of things that I

51:58

should have been really focusing on to understand. the business

52:00

was worth more. So the retail

52:02

revenue doubled for the business. Then

52:05

when you look at the e-commerce side, e-commerce

52:07

revenue nearly quadrupled. Now a big

52:09

part of the expansion plans for Eritzia

52:12

is expanding into the US. And during

52:14

that time between when I first bought

52:16

in 2023, US revenue had

52:18

quadrupled. So clearly the growth

52:20

store in the US is going very, very well.

52:22

And then just to add more fuel to that,

52:24

the US store count went from 29 to

52:27

51. And then additionally, the

52:29

business had been spending a lot of cash

52:31

on the expansion of its distribution centers. So

52:34

when I realized that I was anchor bias, the

52:36

business was punished for its expansion plans and the

52:38

fact that it had spent a couple of hundred

52:40

million on capital expenditures. I took

52:42

the opportunity to overcome my bias and buy more in

52:44

the thirties and a lot more in the twenties. And

52:46

it's done very well for me since. Now

52:49

an interesting trick that Nomad uses to help

52:51

smooth out performance and avoid biases is to

52:53

rearrange performance by year. For instance,

52:55

let's say your performance over a five year period

52:57

is 21%, 43%, minus 16%,

53:02

0% and 28%. With these numbers, you will have

53:04

compounded your money at 13% per annum. Now

53:07

let's say we rearrange these numbers in a thought experiment

53:10

and we make it go in order of negative 16%,

53:12

0%, 21%, 28% and 43%. We still end up with the same amount of

53:14

money at

53:19

the end of five years. Sure, you'll

53:21

go through some pain in those first two years

53:23

of no gains, but you can take

53:25

solace in the fact that you're in line for

53:27

some positive regression to the mean. This

53:29

is just an excellent thought experiment to

53:31

help you really stay resilient throughout the

53:33

bad years that I think will inevitably

53:35

befall literally all investors. Now to

53:38

cap this episode off, I want to share a

53:40

summary of a couple of my biggest takeaways. The

53:42

first one here is that patience is

53:44

crucial for investing performance. The

53:47

businesses you own may make decisions that will

53:49

take years to come to fruition. If

53:51

you buy a business because of its long-term

53:53

thinking, don't make the mistake of selling as

53:55

a punishment for its long-term orientation. Now

53:58

using that example I just gave above. about

54:00

Erytia is literally exactly what happened here.

54:03

The market did not like the fact

54:05

that Erytia's cash flows had decreased significantly

54:07

and gone negative. But the fact is,

54:09

Erytia had said that they were going

54:12

to spend a lot of money expanding the business,

54:14

which is necessary for the further expansion plans into

54:16

the US. So essentially, the

54:18

market was punishing Erytia short-term cash

54:20

flows for trying to grow long-term.

54:23

So second takeaway here is that performance

54:25

will be volatile, especially while running a

54:27

concentrated portfolio. So I think you need

54:29

to learn to live with it. Use the

54:32

thought experiment I just discussed about reorienting your

54:34

returns to note that the end result

54:36

will still come to fruition even if you have some

54:38

down years. And the beautiful part about

54:40

it is that if you have a really big

54:42

down year, a lot of the times the next year is going to

54:44

be really, really good. Obviously, that's not

54:46

a guarantee and things can happen, but from

54:49

my experience, that's what has happened. And from

54:51

looking at the results of other great investors,

54:53

that tends to happen as well. Now,

54:55

my third takeaway here is that

54:57

being a lazy investor whose primary

54:59

activity is inactivity only works with

55:01

high quality businesses. If

55:03

you like chasing shorter-term opportunities, that's perfectly

55:06

fine. But just realize that you cannot

55:08

sit back and do nothing for extended periods of time.

55:11

Now, if you look at the early days

55:13

of the Buffett partnerships, Buffett had a couple

55:15

different buckets of investments. He

55:17

had some that he wanted to hold for shorter periods of

55:19

time and some that he wanted to hold for longer periods

55:21

of time. So you have to

55:23

understand that he had to reorient his thinking

55:26

process based on the bucket that the investment

55:28

is in. So don't just blankly

55:30

put everything into a long-term bucket

55:32

when there's clearly investments that are

55:34

going to be very, very short-term because you'll end up

55:37

hurting yourself pretty badly. Now, my

55:39

fourth takeaway here is that fighting commitment

55:41

bias is definitely a battle worth undertaking.

55:43

Be aware of sharing your ideas with other people or

55:45

a large audience. I think it's perfectly fine. I do

55:47

it and I enjoy it because I

55:50

get a lot of pushback from people about what

55:52

I'm trying to learn about and maybe some

55:54

gray areas in my thinking process, maybe

55:56

areas that I could be wrong on. it's

56:00

really, really important to avoid allowing a stock

56:02

to really become part of your identity where

56:04

removing your commitment bias just becomes harder and

56:06

harder. Instead of concentrating your

56:08

capital on the highest upside opportunities, concentrate

56:11

on the businesses with the highest certainty

56:13

success. I think doing this locks in

56:15

two things. One, it locks in

56:18

the certainty that will hopefully increase over

56:20

time that the business will reach a

56:22

favorable destination in the future. And then secondly,

56:24

I think it just decreases risk. I mean, if your chance

56:26

of losing money goes from 50% down to 40%, 30%, 20%,

56:28

10%. That means the investment's getting

56:33

better and better. It probably means that the investment has a

56:35

stronger and stronger moat. And then lastly,

56:37

on concentration here, just look at

56:39

Warren and Charlie. I mean, Warren,

56:42

99% of his wealth is in one stock and he's done

56:44

very, very well. And Charlie just had a few stocks, but

56:47

he also did very, very well with a concentrated approach.

56:49

That's all I got for you today. Thank you so

56:51

much for tuning into my episode. If

56:53

you want to connect with me on X,

56:55

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56:57

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57:00

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57:02

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57:04

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57:06

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