As we embark on this journey into 2024, I want to express my sincere gratitude for being part of our investment community. In the spirit of new beginnings, I'm thrilled to announce a series of insightful posts throughout the year that will delve into the investment philosophy and lessons of legendary investors.
These are the visionaries who have shaped the landscape of finance, leaving an indelible mark on the industry. Together, we will explore the timeless principles, strategies, and mindset that have defined their success.
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In the realm of revered investors, Nick Sleep stands out as an exemplar of humility and low-profile professionalism. The founder of Nomad Capital, he commenced his journey on September 10, 2001. Sleep's remarkable track record, a 20% (before fees) compounded annual return over 13 years until the fund's closure for personal reasons, solidifies his place as a legendary figure in the world of investing.
The series will be separated into a few parts:
Part 1: Nick Sleep investment philosophy and lessons (2001-2005)
Part 2: Nick Sleep investment philosophy and lessons (2006-2010)
Part 3: Nick Sleep investment philosophy and lessons (2011-2013)
Part 4: Nick Sleep mental models
Today's post delves into Nick Sleep's investment philosophy, lessons and early stock pitches, offering insights into what we can learn from this legend to become better investors. Let’s take a look at his fund first 4 years performance:
Below are some of his early days investment style and thoughts about investing:
On his investment philosophy:
“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.“
On short term investing:
“Many investors are professionally required to “pay attention” to the latest trend for fear of missing out (pay attention and be invested!). The dysfunctionality of the short-term investor was neatly described to us recently by a fellow long term value investor. Imagine, he said, that you knew with 100% certainty of outcome, that on January 1st next year a company would come by some good fortune, perhaps a government contract or license award, which would result in the price of the share quickly rising tenfold. You and I would buy the shares today and wait.
However, to the short-term investor the utility of this piece of information would be naught until after this year is ended. This is because he feels he is required to perform this quarter, next and by year end through fear that sub-par performance might cost him his job. A share which may be flat for the balance of the year is therefore of no use to him. This tale illustrates the dominant dynamic in the markets today: investment time frames are very compressed, and few investors it seems bother to assess the real value of a business but instead respond to the latest data point to determine share price direction.
This is momentum investing and is the mechanism by which expensive shares become very expensive, just as cheap shares may become very cheap. In the above example both sets of investors may even have privately agreed that the share in question was an outstanding investment, but only one would have bought.” Interim letter 2002
On management incentive:
“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” Interim letter 2004
On diversification:
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. Interim letter 2004
On Value vs Growth:
“When investors describe themselves as growth or value it might be helpful to have two questions in mind. To the value investor ask, “what is it about your approach that would have stopped you owning K-Mart for much of the last twenty years?” (K-Mart was a “cheap” stock, as measured by say price to book value – but a dreadful investment, recent performance notwithstanding), and to the growth investor ask, “what is it about your approach that would have stopped you selling Wal-Mart?”. So how does one avoid these mistakes?
The answer lies in analyzing not the effects and outputs of a business, but, digging down to the underlying reality of the company, the engine of its success. That is, one must see an investment not as a static balance sheet but as an evolving, compounding machine.” Annual letter 2004
On investor competitive advantage:
“Broadly 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.” Interim letter 2005
On beating the market:
“Think of how the future will be different from the past. Most people default to the directions and trends that they are currently observing…The important thing is that most things change. In longer term projections, Peter Bernstein tells us, that cone of uncertainty gets wider as time goes out. What are the chances that IBM will be bankrupt tomorrow morning? Probably none. A year from now? Five years from now? What about one hundred years from now? The point being that the possibilities increase as time goes out.
So, what you are trying to do as an investor is exploit the fact that fewer things will happen than can happen. So, you are trying to figure out how that probability distribution works and stay in the middle of what will happen. The market has to worry about all the things that can happen.” Interim letter 2005
On rethinking bias:
“This year we shall have to discard another strongly held bias which is that high inside ownership is a good thing. This too is not always helpful, as shareholders in Northwest Airlines are finding out. In this instance the unions appear to reason that management (who are the largest group of shareholders) will not risk placing the company in bankruptcy and are holding out for the last dollar in negotiations.
Oddly here, high inside ownership is hindering the process that would lead to a more viable airline. Who would have thought that a low share price and high inside ownership could be bearish? But they can. I wonder what other “best loved ideas” we will need to rethink in the coming years.” Interim letter 2005
Stocks discussed/invested:
International Speedway
Matichon
Xerox
Monsanto (mistake)
Stagecoach
Costco
Weetabix Limited
Union Cement
Georgica Plc
No summary is good enough to read replace his original letters. You may read the complete letters from the archive here in his IGY foundation website. He is kind enough to share his wisdom and I think more investors need to know about it.
Disclosure: I am not affiliated to any of the authors or writers and didn’t receive any monetary compensation. It is merely for education purpose and my passion for investing. I might own stocks pitched by them and please do your own due diligence. Cheers!!!