(2021-12-15) Chin Take A Simple Idea And Take It Seriously

Cedric Chin: Take a Simple Idea and Take It Seriously. A couple of weeks ago, Frederik Gieschen published a summary of the Nomad Investment Partnership letters.

Over the course of the next 13 years, through the 2007 financial crisis and out to the other side, they returned 921.1% to investors, roughly 10 times the original capital invested with them in 2001. In 2014, Sleep and Zakaria decided to close the partnership to retire at the ripe old age of 45. They did so because they were bored

they thought that investment was a fun intellectual game, but that they had solved the game.

Over time, however, Sleep and Zakaria began to dislike these ‘cigar butt’ investments. They realised that if they kept buying such companies, they would have to repeatedly exit their positions and find new ones

They wanted compounders — great companies that could grow. (compounding)

In the beginning, Nomad invested in ‘cigar butt opportunities’ — that is, so-so companies that were valued at unreasonably low prices. This included, amongst other investments, four Zimbabwean stocks

And so they began to ask a series of very interesting questions.

Sleep and Zakaria began to realise that there was something truly special about Costco’s model. They started asking themselves what this special property was

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

This was the first instance of the phrase ‘scale efficiencies shared’ in their letters

Sleep and Zakaria took this single insight and took it very, very seriously, eventually working out all of its possible implications, and shifted their fund to be fully invested in companies with this property.

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).

Costco has some of these attributes

but it is not the lightest of them all. For that one must turn to the Internet. In our opinion a business such as eBay could be the most valuable in the world

It’s worth noting that at this point, Sleep and Zakaria were already looking at Amazon. A year later they began buying shares of the retailer; a year after that they took Amazon up to 20% of the fund

they asked what was so difficult about this model, and why it was so rare, even amongst companies with scale economies:

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 reengineering.

In 2010, Sleep began to realise that culture was an important explanatory variable for the model: Cultures that care about the little things all the time are very hard to create.

Investors know that in time average companies fail, and so stocks are discounted for that risk. However, this discount is applied to all stocks even those that, in the end, do not fail. The shares of great companies can therefore be cheap, in some cases, for decades.

they asked: “what is it about growth stocks that dooms them to failure?” The answer is that success encourages competition, and capital flows into an industry to compete away the excess returns. Like all heuristics, this works most of the time

But what of those that don’t fail? Michael Dell succeeded by keeping costs low and passing back his scale benefits to the buyer of his PCs

They asked: of all the possible business models in the world, what is the best possible business model?

What matters is durability of compounding growth

Strong network effects

Strong brands give businesses pricing power, but do not prevent the entrance of new competitors with equivalently strong brands, nor protect the company from the disadvantages of scale

In contrast, a business with scale economies shared passes on the benefits of its growth to its consumers