Dear Mr Buffett after 13 happy years of running The Nomad investment partnership Zach and I have decided to close the fund the process requires us to return cash to our investors and so after many years as shareholders in Berkshire we have recently sold our shares it appears to all the world that the performance that Nomad has enjoyed over the years was created by Zach and me that is not the case as time goes by the performance
that our clients have received is the capitalization of the success of the firms in which we have invested in other words the real work is done by you and the good people at Berkshire the purpose of this letter is to say a very big thank you and let you know that you have made a real difference Nomad was not a particularly large fund but over the years it did make around $2 billion for its clients which were predominantly
Charities and educational endowments Berkshire was a big part of that that strikes us as capitalism working well for our part Zach and I are Keen to leave the professional industry behind and spend our time in more caring Pursuits Zach has his various charitable causes and I have in my mind to set up a center to provide respit care both of these activities will require long-term funding and so while you'll lose us as
professional investors we will be able to repurchase our shares both privately and for the Charities that we run you don't get rid of us that easily we will be keeping the office and a new sign will be hung above our somewhat shabby front door we look forward to seeing you at the next AGM and extend an invitation to visit us at burnsall Street with the warmest regards Nick sleep and then Buffett writes back dear Nick thanks for
sending along the update you and Zach have made the right choice I predict you will find life is just beginning best regards Warren E Buffett and so those letters appear at the very front of another homemade book that I have created I read all 110,000 words this is the full collection of The Nomad investment partnership letters that were written to Partners between the years 2001 and 2014 and they were written by Nick sleep I
printed Nick's letters out and put all 219 pages in a binder and so I want to begin with something that Nick repeats and something that he leaves at the end of a lot of his partnership letters and so he writes a final word on the need for patients we are aware that several investors are new to the fund and so it may be worth reiterating some ground rules so that you know where we stand one of nomad's key advantages will be
the aggregate patience of its investor base we are genuinely investing for the long term few are if Nomad is to have a competitive advantage over our peers this will come from the capital allocation skills of your manager if any and the patience of our investor base only by looking further out than the short-term crowd can we expect to beat them it is for this reason we named Nomad an investment partnership and not
a fund the relationship we seek is quite different and so the note I left myself on this page is really two ideas or why I spent two weeks why I did an episode last week that gives an overview of how Nick and Zach built their investment partnership and then why I would spend another week reading you know 110,000 words of Nick sleep's investment partnership letters and so it's obvious from reading the book last week and then
reading Nick sleeps letters this week they didn't copy their Pierce Nick and Zach ran their business based on the out of their own thinking and then they invest in Founders that do too and then I would argue that it's their willingness to do the work necessary to trust their own judgment that allowed them to arrive at a very valuable earned secret and then the willingness to change their behavior to build their
entire partnership around that earned secret so that's really what I'm going to focus on and I want to talk to you about today a lot of what I found interesting in the partnership letters has nothing to do with investing it's their analysis of how Jim Syle ran Costco it's there analysis of how Jeff Bezos ran Amazon is there analysis of way this is kind of strange this business model keeps reappearing throughout history and gifted Founders
are able to use it and apply it to vastly different Industries and keep having wild success and so Nick writes about Charlie monger's cancer surgery approach he's analyzing this business that they made an investment in I talked about it last week it's called Stage Coach the founder retires New Management kind of runs it into the ground so the founder comes back out and when you realize like there's this beautiful
business under here but you kind of layered all this crap on top of it and so what Monga realized is there's many times in business history where well you just need to do the cancer surgery approach he says this often works because there's normally a jewel at the heart of most companies that has often been used to fund new Ventures that Jewel has been taken for granted by inpatient management as the jewel
becomes diluted by less successful projects aggregate performance declines and so Nick talks about the fact that monger and Buffett saw this in Coca-Cola in the in the mid1 1980s because at that time Coca-Cola had become a poorly defined conglomerate including a shrimp Farm Winery and a film studio as the poor businesses were cut away to reveal the jewel that is syrup manufacturing and marketing operation the shares of
Coca-Cola Rose over 10 fold in the succeeding decade there's a hilarious story that comes to mind when the Mark Parker who's the former CEO of Nike asked Steve Jobs if he had any advice for him and Steve said Nike makes some of the best products in the world products that you lust after they're absolutely beautiful stunning products but you also make a lot of crap just get rid of the crappy stuff and focus on the
good stuff just get rid of the crappy stuff and focus on the good stuff this idea that a jewel can become diluted by less successful projects as aggregate performance declines the reason I started here is because what's fascinating about reading these letters but also in I'm going to go through these in chronological order so we can see the evolution of Nick sleep's thinking it's also the same phenomenon that you and I see when you go through a
biography and you go through somebody's life chronologically you see them slowly figure it out they struggle and they're trying to really get to the idea the main idea and the main focus of their life and what's fascinating about reading this part this at the very beginning Nick doesn't understand he's describing the cancer surgery approach he's describing Coca-Cola he's describing stage coach at this point in
his life he doesn't understand he's going to also use this principle in building his business he is going to take the advice of Steve Jobs even if he never heard it he's going to get rid of the crap which is these other Investments and just focus on the good stuff and he's already stumbled onto a really great business and this is the beginning of his understanding he doesn't know how deep he's going to go on Costco so this is 2002 and he's like
well Costco you know we just bought the stock there's really no need to fix this business because it's performing well already and so there's something that Nick will mention later on he's like well you know we're trying to anal analyze businesses that like are Mouse now but may turn into an elephant and try to reverse engineer like how that happens and so you start to see this at the very beginning when he starts
talking about Costco he's like well they operate on this everyday low pricing strategy which he'll refer to moving forward as edlp the way I would describe that is if you have not listened to episode 360 listen to episode 360 after you listen to this episode try to find that book it is written by Bob kierin who's the founder of fenol that book and the way Bob ran fenol all centers around this one idea that the leader of a
company has to keep the entire organization committed to a common goal Costco's common goal is that we are going to commit to this everyday low pricing strategy and they commit to it every single minute every single hour of every single day as we're about to hear with this great Jim Cagle story in a minute but I gotta before I leave this page this is 2002 and he's just start talking about the scale economy shared
and he's just starting to try to think about and understand it's going to take a long time to understand how powerful this idea is but he starts talking about this new idea of scale economy shared which is going to be their earn Secret the single best thought that they ever had the one that they're going to let dominate everything that they do and so Nick is like okay so Costco is committed to this strategy of edlp and by them
sticking to this standard markup is a way that they all the benefits that they get from from scale as a company are returned to the customer in of lower prices which in turn C encourages growth and then extends scale advantages and it illustrates a level commitment that the founder has to this idea this is what he says to understand how important edlp is to Jim Sagal Costco's founder consider
the following story so Costco gets this incredible deal better deal than they normally get when they buy 2 million pairs of designer jeans they wind up getting them for $22 so $10 less than Costco has sold the jeans for in the past so they offer this huge markup you could essentially mark it up another 50% and you'd still be half the cost of most other retailers so one of Costco's buyers recommends taking a higher gross
margin than usual more than the normal 14% markup since no one would know so he says that the Jim Sagle and insist on the standard markup arguing that if I let you do it this one time you'll do it again the contract with the customer which is very low prices must not be broken this is a really important point to consider think about this what the buyer is trying to do is do what's better for the company what he thought
was better for the company at least what was better for the company in the short term what Jim Syle and other great Founders do is they always do what's better for the customer because if you do that over the long term that is then what is better for the company and so when I read this section this entire paragraph I just stared at the page I was like I've seen this before this reminds me of Walt Disney so then I go
to Founders notes I type in the keyword search Disney leather straps and what is remarkable is we see a very similar story play out when Walt Disney is building Disneyland they are over budget they don't have enough time they have a specific date that they have to open by and so you see this conversation that Walt Disney is having with one of his employees and his employee does the same thing let's cut a corner here let's
compromise a principle because short term it's better for the company at least in their misunderstanding and so they are finalizing a ride and funny it's stage coaches because they're hor drawn stage coaches same name as Nick as one of Nick's Investments on the previous page and so let me read from this book called Disney's land they were among the first of the Park attractions to be finished but the pressure of time was already
Weighing on everyone one day John Hench stopped by to check the progress on the coaches and had an idea which he brought up to Walt why don't we just leave the leather straps off Walt the people are never going to appreciate all the close-up detail Disney treated Hench to a tart little lecture you're being a poor Communicator people are okay don't you ever forget that they will respond to it they will appreciate
it Hench didn't argue he said we put the best damn leather straps on that stage coach you've ever seen I think what Walt understood is what Jim Sagle said if I let you do it this time you'll do it again this entire organization is going to be committed to this one common goal everyday low prices or as Jim sagal's Mentor so price we'll talk about later says focus on getting the lowest possible price to the customer always so
back to Nicks letters many retailers do not operate in such a way Costco's management describes this strategy as easy to understand and hard to operate now a few years later in 2004 you see this this is one of my favorite Parts because this is this happening this should be happening as you know you're reading more biographies you're studying more entrepreneurs studying more companies you start to see that their
ideas right you're applying them to your own business and so they're studying all these what they they want to you know hopefully think and will turn into uh like large wonderful business businesses you know Costco is going to only get a lot bigger from here and then they're going to use the insights that they derive from Costco to make a massive investment in Amazon but with this paragraph you can't help but notice that
they're oh they're they're applying it to how the business that they're building and how they're spending their time so this is job one two and three for your manager is investment performance few practice this approach we work under the assumption that if performance is reasonable then the level of interest in what we're doing will increase and the partnership will grow in time the principle behind what they're saying is very similar to the
the same principle that they identified with the way Jim Syle ran Costco it's like well if we just focus on getting the lowest possible price to the customer if that is job one two and three then the customers will respond with loyalty that will compound over the years and Costco will get bigger just like they said Nomad the partnership will get will grow in time and so the note I have is actually longer than the
paragraph So the first thing is keep the thing the importance of keeping the main thing the main thing the importance of focusing and concentrating and that is related to part two which is one of my favorite ideas when they knew that they had uncovered a deep truth and Nick says if it's a single best thought you have ever had in your life it needs to dominate everything because you're not going to get many insights like that and
if it's your single best Insight your single best idea then obviously it's what you should spending all your time on there is a post written by one of the co-founders of paler talks about what he learned from working with Peter teal and this part of the post I have saved on my phone and I think it applies to exactly what's taking place here do not divide your attention focusing on one thing yields increasing returns for each unit
of effort at a micro level an extra hour of focus on the current project has a much higher return than an hour on something new or worse five minutes each on 12 new things before you ever do something new you should understand the opportunity cost versus existing things don't rationalize that something you want to do is complimentary when it's not at a macro level understanding that applied effort has a convex output curve
is a very useful discipline when considering New Market areas this convexity means that the opportunity cost of transferring resources from existing projects to new ones is high unless the new area is incredibly valuable anything we can do to extend an existing convex curve is worth so much more and so towards the end of the partnership they are known for their heavy concentration in just three things
and like you and I talked about last week in one case 70% of their net worth I think this was uh Zach's net worth 70% of Zach's net worth was in Amazon just one stock but we're in the 2004 letters and they haven't yet learned the importance of betting heavy yet this is what's so remarkable about reading them is you see this constant evolution of thinking so at this point they have Holdings ranging anywhere from at most
their highest one is 7% of their entire portfolio down to 3% and you see that Nick is thinking about this he's like well this is just like Charlie Monger Char Monger is right when he says it's aggravating to buy just a little bit but this is a hard question to answer so it says in reality opportunities in which we are comfortable to deploy Capital are rare and the highest conviction idea is the rarest of them all the issue then is
how much to invest in each idea and this is Nick's takeaway from thinking about the Kelly Criterion the common sense outcome of that equation is that if one is certain of being right one should invest the entire portfolio in that idea but does anyone do that so he goes back to history as far as we are aware only the early Buffet partnership portfolios had anyone 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 the logical extension of this line of thought is that nomad's portfolio concentration has been at times too low and so in the margin of this homemade book I have I was like all right starting to change their mind when do their actions reflect that and on the very next page he has a section called the likely evolution of
the partnership Investments I love this part I underlined almost the entire part in the office we keep a list of companies assembled under the title super highquality thinkers this is not an easy Club to join and the list currently runs to 15 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 the anointed few are there because they have chosen to outthink 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 this goes back to the Charlie munger's cancer surgery approach okay so he says the partnership's successful investment in
stage coach has been due to the firm's shrinking strategy not its growth at National Indemnity which is an insurance subsidary of birkshire the firm's ability to write insurance only when pricing is good and stand back when
pricing is poor even if revenues decline is a wonderful example of capital discipline and good Capital allocation after all why grow if returns are going to be poor surprisingly few companies have the strength to just sit it out
this part made me laugh out loud we ask companies with poor economics why they want to grow and Senior Management look back at us incredulous at our line of questioning I guess their answer is we'd like to grow so we can lose even more money the super high quality thinkers are are best guess as those from firms whose shareholders could abdicate their right to trade stock which means you're advocating the right to allocate Capital
themselves right Nick is outsourcing that to the buffets the Bezos the Sagal so the super high quality thinkers are the best guest of those firms whose shareholders could abdicate their right to trade stock sure in the knowledge that their Capital will be well allocated for years to come within the business this list is a group of wonderful honestly run compounding machines that is what he's looking for 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 and what I write there is answering the question on the previous page and I wrote Bingo on the previous page starting to change their mind when will their actions reflect that he's having a very honest convers he's like this is the outcome of our own thinking we have
this group we've identified a a handful of potential honestly run compounding machines this is our terminal portfolio this is where we want to go but then we compare that list to our portfolio they don't match and so then Nick elaborates on the honestly Run part of this now he doesn't want just a compounding machine he wants an honestly run compounding machine what does that mean there are only two reason 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 fact put us out of a job we will be pleased if a little bored and he arrives at that conclusion because he's like well if we can invest in them early we can invest in Costco and Amazon early we don't have to do anything else because time is a
friend of a good business in fact I like the way Buffett put this in his shareholder letters better he says time is a friend of the wonderful business and the enemy of the mediocre and so Nick says today in 2004 we have made two investments in one wonderful compounding machines and only one of those is Meaningful meaningfully represented in our portfolio that's Costco what is the probability that say over the next 10
years a good portion of these super high quality thinkers will be priced at0 50 cents so there's some kind of pullback in the stock right our betting is that odds are reasonable the trick is to do the work today so that we are ready if you go back to the leelu's lecture with the Columbia business school students that's what he kept telling them you have to be a learning machine you have to be doing the work now he he
referenced many times that it takes a long time now but it makes you go faster later on but that you'll study something he would study like an American company for like 15 years it would take him 15 years to find the Asian counterpart Nick is telling us something very similar here we're going to think this through we're going to analyze this business model we're going to try to find these super high quality thinkers these
compounding machines and then we are going to be patient we are going to wait because the probabilities are high that we able to get a good price to buy in the trick is to do the work today so that we are ready and so in addition to spending time analyzing companies and industries and trying to find these compounding machines they also talk a lot about or Nick talks a lot about all the mistakes that his peers and other
people in uh the industry make he says successful investing is a minority sport when I had dinner with Charlie Monger I have a list on my phone of all the notes I took uh from the conversation and one of the last things that Munger said to me at dinner was that being good at investing is a very rare skill it is not distributed widely and will never be and that has to do with behavior so Nick sleep says the best talk on investing
wasn't about investing and it was Charlie MERS talk the psychology of human misjudgment and so what Nick is doing here he's thinking through he's like well what the problem is what if we're right what if these are wonderful businesses what if Costco is going to get much bigger from here why is it then when you look at the history of investing that so few people cannot see success and what he means by that is
they sell way too early so he says we take no comfort from the fact that not seeing success is a perennial investment mistake in the 1950s a large Baltimore based fund management company sold their client shares in IBM only for the shares to appreciate at the point that the value of the shares sold would become bigger than the whole fund management company itself remember this because he tells it the same story many years in
the future and I think he does an even better job what we are trying to do today is to avoid the Baltimore company's second mistake which was to sell an equally big stake in Walmart in the 1970s the point he's obviously making is hey just hold on to IBM in Walmart and you didn't have to do anything else 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 one must see an investment not as a static balance sheet but as an evolving compounding machine and if you did that you would not have sold Walmart in the 1970s and so Nick starts sharing his thinking about what is the engine of Costco's success and is there some traits that some actions that it's taking that would cause their customers to maintain this loyalty and this
commitment to Costco over a long period of time I told you uh last week you know my wife's family has been shopping there for almost 30 years they are extremely committed to Costco so Nick says number one operating costs are low indeed very low it is indicative of the paranoia with which the companies run that costs are measured in basis points number two the wholesale price is as competitive as it can be the key to negotiating terms
is that the number of items in a store so the skus are fixed at 4,000 and the right to fill one of those spaces is auctioned with the supplier that provides the best value proposition to the customer winning space on the shop floor so he talks about how ruthless they can be with their uh suppliers that on their website it lists a criteria required to become a Costco supplier and Nick highlights this one section we
expect all vendors to consistently and voluntarily quote the lowest possible acquisition price of available on all items a vendor who does not consistently and voluntarily quote its lowest price to our buyers will be permanently discontinued as a purchasing source for Costco this is Nick's response to that g good grief one strike and you're out number three revenues need to be very high revenues will be high if the other
factors number one and number two are favorable if operating costs are low and prices are as competitive as they can be the issue is what the company then does with the revenue advantage 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 of Seattle benefit from the Fern'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 in the office we have a whiteboard 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 few share them
it's the sharing that makes the model so powerful the company Grows by giving back 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 to raise the probability of long-term success when Costco continues to recycle cost savings to the consumer it is lowering the probability of failure and before I read this next
sentence to you remember it is 2004 when he is writing this amazon.com may be following this path as well and so then he tries to reconcile like this business model makes sense to us this is phenomenal if you're a customer but why are the shares mispriced why why is this so cheap and so he lists what some criticisms that Costco gets at the time the company has low margins and it's funny that he's mentioning both Costco and Amazon at
this time because remember one of B Jeff bezos's most famous quotes is that your margin is my opportunity so the people are like well we don't want to buy the stock because Costco has low margins and Nick sleep says true but that's the point the firm is deferring profits today in order to extend the life of the franchise and so as he continues to analyze Costco he says there's an inter question what characteristics could one
bestow on a company that would make it the most valuable in the world what would it look like and he says such a firm would have a huge Marketplace that would offer size they would have higher barriers to entry which would offer longevity and very low levels of capital employed which would offer free cash flow Costco has some of these attributes it is also more asset light than its peers but it's not the lightest of them
all for that one must turn to the internet I'm going to pause here before I read the next sentence because I promise you you're not going to be able to guess what the next sentence is we just got going through going through the the the benefits of Costco they mentioned Amazon they mentioned they can only understand a few business models and this is one of them Costco is great but imagine if you had Costco on the
internet and given all that we take this strange turn right here cuz they said well for that one you got to turn to the Internet so in our opinion a business business such as eBay could be the most valuable in the world so no Costco is not perfect perhaps we should own eBay as well no I I wrote on the this is the next page so you can uh read these for free online and i' if you like reading physical
things like I do you can print them out some of AG 52 on 51 on page 51 they're talking about you know uh the benefits of Costco they talk that the fact that Michael Dell is also using this model by keeping cost low and passing uh back scale benefits to the buyer of his PCS and that amazon.com might be following this path as well on page 52 it's like well Costco could be great but what if it was on the internet so maybe it's
eBay and I wrote in a giant letters in the margin the answer was on the previous page the answer is Amazon they just don't know it yet now they will arrive at that and I think that they're the the most the majority like that $2 billion that they made I think the single company that contributed most of that if I'm not mistaken it's Amazon and it is always helpful to think about what was going on when these words were
written so if you go I went and looked up like what because you read about early days of Amazon you I've read every single book I can find and for the longest time people thought like Bezos has no chance against eBay and think about this in the end of 2004 the market cap of Amazon when Nick sleep was discovering this earned secret was n was $18 billion 18 billion the market cap in that same time for eBay was 77 billion
in today's world we're living in that sounds silly but if you go back to the early 2000s there was a ton of stuff written on the fact that Amazon stands no chance against eBay and so on the next page he gives us his summary of thoughts on Costco in our judgment Costco is a cost disciplined intellectually honest High product Integrity perpetual motion machine trading at a discount to Value I think we will do quite well your manager has
already made his first mistake in investing in Costco from not buying enough towards the end of his partnership letters Nick sleep writes something that's excellent the fact that you know these ideas that work today they worked in the past and they will build empires in the future too that is why I read 110,000 of these words this is what I'm choosing to focus on as I speak to you the one the first thing
that got me really interested in Nick's sleep is not his investment performance it's his observation that he lays out in the following quote he says the best investors aren't investors at all they're entrepreneural who never sold and since Nick is an investor he's trying to learn from that from learning that why these entrepreneurs not sell he says the biggest mistake an investor can make is to sell a stock that goes on to
rise tenfold not from owning something into bankruptcy but that's what everyone thinks at least judging by the questions that we get from our clients we got questions about our holding in Northwest Airlines rather than the sale of Apple earlier this year but selling Apple has cost us more so again that speaks to Nick's own point about how difficult this was when he's talking about that firm that sells IBM in the 50s and
Walmart in the 70s he's not like hey look at these idiots they're so stupid he's making the point that that mistake is repeated over and over and over again when you look through history it's arrogant to think that you're not capable of making the same mistake so how do we avoid that and I think we'll talk about this later but just in case I forget the idea that the best investors aren't investors at all their
entrepreneurs who never sold that has to do with the love that an entrepreneur feels for the business that they're making that they're creating Sam Walton is not looking at his stock in Walmart and maximizing for the best return on the most dollars in his bank account he was focusing on building something great that served other people over a very long period of time in other words sometimes it turns out that the best
financial decision is not a financial decision at all now we get to 2006 and they start to realize oh my God it's not eBay he doesn't say that it's not eBay it's Amazon I there's before he gets into analyzing Amazon though I think he he hits on something that's very fascinating that is related it's it's on the page before he gets an Amazon but I think it's related to how he thinks about Amazon and he's like you know this
is a really weird thing in the uh how we teach economics he says there's a blind spot as the overwhelming mythology methodology for research in economics has been to take observations over a short period time as if cause and effect sit on top of each other remember that line for when we get to Jeff bezos's own shareholder letters who are who are who are quoted heavily in Nick sleep's partnership letters okay it's this really weird thing we're
assuming that you know observations happen over a short period of time as if cause and effect sit on top of each other and really this all ties to his main point of why having a long longer view a longer term view can be just a massive advantage and he makes the point that both Costco and Amazon at this time they're penalized by the public markets because they're giving so much of their scale efficiencies back to the consumer
and so he goes okay well how do we how should we think about this how should he calls them price give backs here's what Jeff Bezos says had to say in his last year's annual report we have made a decision to continuously and significantly lower prices for customers year after year as our efficiency and scale make it possible this is an example of a very important decision that cannot be made in a math-based way
when we lower prices we go against the math which always says that the smart move is to raise prices we have significant data related to price elasticity with Fair accuracy we can predict that a price reduction of a certain percentage will result in an increase in unit sold of a certain percentage with rare exceptions the volume increase in the short term is never enough to pay for for the price decrease however our quantitative
understanding of elasticity is shortterm we can estimate what a price reduction will do this week in this quarter but we cannot estimate the effect that consistently lowering prices will have on our business over five or 10 years it's exactly what Nick was saying on the other the mistake that the academics and economics make they act like cause and effect sit on top of each other Jeff is saying yeah okay you can quantitatively
understanding what this price reduction will do this week or this quarter but you can't say what effect it'll have over the business for 5 or 10 years this is why one of my favorite lines about what what the role of the founder actually is the founder is the guardian of the company's Soul this is an example of that our judgment is that relentlessly returning efficiency improvements in scale econ economies to customers in the form of
lower prices create a virtuous cycle that leads over the long term to a much larger dollar amount of free cash flow and thereby to a much more valuable Amazon we have made similar judgments around free super saer shipping and Amazon Prime both of which are expensive in the short term and we believe important and valuable in the long term the timing in which Jeff is writing this and which Nick is commenting on it is
really important this is a time when few people are buying Amazon Nick and Zach have their earned secret they are half a decade into their partnership and so Nick writes this is a summary of the scale efficiency shared model that we dealt with in detail in our analysis of Costco years before and is deployed by companies which have now come to dominate Nomad which is his holding in Costco Dell Amazon and Berkshire if the share price is being
set by those with an eye on the next data point then they can't also be looking out for the long-term value there are few traders that disagree with BAS value creation process but they don't think it will show up in the numbers just yet the Traders have many small ideas and we have one big idea good luck to them it is not strictly a math-based equation and there's no guarantee that investment spending will
always work and he quotes Bezos again math-based decisions command wide agreement whereas judgment-based decisions are rightly debated and often controversial at least until put into practice and demonstrated any in institution unwilling to endure controversy must limit itself to decisions of the first type in our view doing so would not only limit controversy it would also significantly limit Innovation and long-term value
creation that is the end of bezos's quote this is Nick's one-word response amen and the next sentence he says I think Bezos would run a good investment fund but that is the point good investing in good business decision are synonymous and so in one of the 2007 partnership letters he talks about how and why Amazon can get even better now keep in mind the following year he doesn't know this yet the following year
you're going to be able to buy Amazon stock for like $35 okay so he's asking the question like how do we know that a business will actually grow from a mouse to an elephant and he identifies the same traits that in the physical world that Costco has and then it could be superpowered by the internet so you know several things are important a business ought to be able to self fund its own growth second barriers to entry should
increase with size that way the company's moat is widened as the firm grows and then the giant advantage that Amazon has over Costco is that on the internet power law is very high and this implies that businesses like Amazon have a shot at being far bigger quicker and more profitable than their physical world equivalents and the fact that it's led by a customer Centric founder this combination makes us think that we may
have a mouse that can turn into an elephant to those who argue that Amazon is large already we ask you two questions what do you think e-commerce will be as a proportion of us retailing in 10 years time and what do you think it was last year so the answer to that second question is 3.1% of all retail sales happened online in the year 2006 and so then he goes back to this unresolved problem it's
like everybody else is Diversified that doesn't make a lot of sense to us how should we be thinking about this this is very difficult and so since they had bought Amazon it went up twice so said after the doubling of the share price it'd be easy for Zack and me to claim victory high five and sell our shares in Amazon in previous Nomad letters we have argued that the biggest error an investor can make is the sale of Walmart
or Microsoft in the early stages of the company's growth we wonder would selling Amazon today be the equivalent mistake of selling Walmart in 1980 and so he talks about let's invert let's invert the way to construct a portfolio the other way to construct a portfolio that's different from how other people do it is to invert and start at 100% waiting and work down this is what Founders do he's really saying without saying what if you invested like
Founders invest right it's 100% same walon 100% of his net worth was in his company and he says now we are not advocating all the fund in Amazon well just not yet at least and here's the crazy thing that would have been their best performing decision assuming going to put all your money into what you've already invested in they didn't know it then obviously but they the best performing decision would to do just
that allocate the entire fund to Amazon and he tells a wonderful story why this is so difficult and this is hilarious he says it was recently reported that oil had been found not in the far-flung reaches of the globe but under the headquarters of Exxon in Irving Texas and not by Exxon sometimes what you are looking for is right in front of you if Exon can make that mistake we all can so now we're in the great financial crisis
of 2008 remember Nick to said that the greatest speech on investment wasn't about investment it was about the psychology of human misjudgment and he's talking about you know everybody's panicking I think they're going to wind up being down like 40% this year 45% the uh at the at the end of the year and he says in the the letters before this even happens I think he's only down to 20% this time he goes I know it doesn't seem
like it but I promise you this is the best possible time to be an investor and he's looking at the underlying strength of Amazon it's completely uncorrelated to stock price and he cannot believe it this next section goes over many many pages it's one of my favorite parts of his entire letters and so he's about to make the point using Amazon as an example that hey customers response incentives like all people do and
Amazon's sharing of these benefits of its scale will make them grow much farther from here and you can see it with how they're actually performing in the middle of this great f cial crisis is happening in 2008 and so he's comparing Amazon's strength with the lack of strength that normal retailers have so he calls them high low you know people that say Hey you know they they get you in the door by essentially
heavily discounting having like a loss leader and and the hopes that once you're in the store you're going to buy something that they have a higher margin on so he's going to call them High Street peers okay Amazon's High Street peers could price their products at net income break even and still not undercut Amazon's prices or profitability for these high streight competitors the game is over he's writing this in 2008 when
everybody's panicking Nick is thinking very rationally and seeing things unbelievably clearly they will leak revenues to more efficient Rivals as customers respond to the incentives of consistently low prices and convenience scale economics works well in bad e Economic Times as well as good on the busiest day in the runup to Christmas this year in 2008 order volumes at Amazon were 16% higher than the previous year compared to the
overall retail industry which are down 10% in the last few months Amazon has been priced in the market as if it would not grow in the future despite some of the best growth prospects we can imagine that is a very rare combination and there's a hilarious illustration of this point that he Nick's right scale economics works well in bad Economic Times as well as good this happening in 2008 back when there was a recession in
the early 1990s Sam Walton was asked about the recession that was happening and he said I've thought about it and I've decided not to participate when you have order volumes at Amazon growing 16 % year-over-year in one of the worst financial crisis that the in you know half a century or whatever the time frame was that's Jeff bezo saying yeah I thought about it I'm not going to participate and so it's exactly when
everybody's panicking when he's investing in Amazon he says in our opinion just a few things in life are noble and it is because just a few things are noble that noad has just a few Investments the Church of diversification is seen as an insurance against any one idea being wrong we would propose that if knowledge is a source of value ad and few things can be known for sure then it Li logically follows that owning more stocks does not
lower risk but raises it Sam Walton did not make his money through diversifying his Holdings nor did Bill Gates Andrew Carnegie or John D Rockefeller great businesses are not built that way indeed the portfolios of these men were more or less 100% in one company and they did not consider it risky go back to that quote the best investors of all time are not investors at all they're entrepreneurs who never sold and so he's
asking the question why is it that no one but the founding Walton family owned Walmart all the way through Zach and I were told a story which we enjoyed enormously and might help illustrate this point in the early 1970s a large successful fund management company analyzed its portfolio and discovered that their sale of IBM 30 years earlier had been a huge error of omission if they had instead kept their IBM shares
for the last 30 years that stake alone would have been larger than the total funds under management they all agreed to learn from that particular mistake and as so often happens went back to their desks and got on with life before as if nothing had happened around the same time that they realized their mistake they also made a decision to sell their stake in Walmart which 30 years later would be worth more than
there then to be funds under management in terms of dollars of opportunity loss it is likely to be the biggest single error that firm will make and so then he makes a point a few pages later like you cannot just focus on the outputs if you do you're going to sell you have to really understand the central engine of success you have to understand that business deeply is this is why he says so few things can actually be known and
if you can only know a few things well then of course you need to be heavily concentrated and bet heavily it could be argued that lots of things had to go right for Walmart to grow for 40 years that is certainly true but at its heart a very few simple things really mattered in our opinion the central engine of success at Walmart was a thrift orientation so low costs low waste fueling growth with the savings shared
with the customer that is the Deep reality of the business and so you could pause there if you're interested in investing you say okay so who's doing this now who today is the Walmart of the 1970s or you can ask yourself okay how do I apply this to my own business so my business the one I'm running today can compound for decades and he wraps this up beautifully because he's a they're asking essentially the reason they're
studying the Walmart and reason they did all the work on Costco is they're like is Amazon are Walmart and I absolutely love this section because it's really comes to what you and I've been talking about the past few weeks effort and opportunity costs Monger says that all wise people the way wise people make decisions is through opportunity cost and then effort so it says when Zach and I troll through the stock market these
last 18 months we read a thousand annual reports and visited and interviewed 300 companies we had four main choices one we can add to our existing Holdings two we can invest in new businesses three we can invest in growth businesses or four we can invest in cigar butts overwhelmingly we have preferred our existing businesses to the Alternatives we are not saying that Amazon is the next Walmart time will tell on this
front but we are asking the question what if it is and if the answer is yes then the answer is on the next page it talks about the investor self claran who wrote margin of safety was once challenged on whether Buffett's track
record was statistically significant since he traded so little to which claran answered that each day Buffett chose not to do anything was a decision taken too when I read that I assume that Nick is seeing himself in that story
right now in 2008 he's like I got I got Berkshire I got Amazon the key is to not mess that up he the key is to not interrupt this these honest compounding machines which in itself is a decision a daily decision not to do anything and arguably more difficult than to do something because I think we are naturally wired to do something to take action and what made me want to spend time studying Nick sleep and Zach and
lelu and Bezos and everybody else is because of this idea remember what lelu said he was asked he's just like well how do you how is your approach different than other investors that are less successful than you he's like I I don't spend any time worrying about what other investors do I spent all my time studying great companies and studying great Industries if Nick and Zach were worried about what other investors were
doing at this time they wouldn't be doing what they're doing they wouldn't have been buying Amazon they wouldn't have been talking about Costco and so there's this unnamed founder that is running one of nomad's Investments that said this in a private meeting I'm I this has got to be Bezos they don't say it's Bezos but listen into this and I think again let's let's just assume this is basos basos is running his business
this way I would argue that lelu ran his business this way and then Nick and Zach were running their business this way if you want to be successful and we do then you have to be willing to be misunderstood okay come on this has been a main theme the last month and do things that do not seem sensible to most people for example if you the employees come into the office in the morning thinking how are you going to beat
number one number two and number three in the industry then our business is the wrong place for you we start with the customer and work backwards he continued that rather than set your standards by what others do the business benefited from a Divine discontent with the status quo which kept us on our toes and the business improving irrespective of what the competition was doing in other words
his company had an internal compass with True North pointing to what was right for the customer sounds a lot like what Jim syal did at the beginning he's like hey suppliers like hey we got got such a good deal on these designer jeans we can mark them up you know another another $10 no one will notice and he's like no I'm not going to do that because that violates my internal Compass which which points to always doing what's right for
the customer and Jim sagal's thinking on this was heavily heavily influenced by his mentor Soul price I've done two episodes on Soul price if you haven't listened to them yet it's episode 304 Soul price the founder who taught Jim Syle Sam Walton Jeff Bezos Bernie Marcus it's based on a biography written by his son his son listen L to that episode and sent me a very very kind email so Zach and Jim or Nick and Zack rather are
meeting with Jim and he says uh Jim suddenly stopped in mid-sentence his face lit up I must show you this he said and he disappeared into a filing cabinet he emerged with a memo from 1967 written by Soul price and he gave them a copy they framed it and hung it on the office wall the memo says this this is soul price this is what Jim thought was super important 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 right kinds of goods we want to sell operating efficiencies lower Mark markdowns greater turnover increasing
the retail prices and justifying 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 traffic how much
the traffic will bear and when the race is over fedmart will be there this is Nick's commentary the that is the best summary of the business case for scale economic shared that we have come across 43 years later 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 Jeff Bezos almost impossible to create if not
put in place at the firms Genesis and then I want to end on what I think is the main point and the main idea behind this so that these ideas are Timeless and are transferable to our work when we study truly great businesses we find that very often it has been simple human attributes that have led to their success you feel differently drinking a Coke than a no brand Cola or you may feel differently towards a business that consistently
undercuts the competition in price or a delivery service that literally goes the extra mile and picks up return items and the reason you have these feelings and the stimuli that produce them have hardly changed in Millennia it is interesting to note that the business model that built the Ford Empire 100 years ago is the same that built Sam Walton's in the 1970s herb kellerer in the 1990s are Jeff bezos's today and it
will build empires in the future too and that is where I'll leave it for the full story highly recommend reading the shareholder letters all of them they're available for free on Nick's charity website I will leave a link down below and then if you don't want to read all 218 219 pages of the sharehold letters I would heavily recommend buying William Green's book the one I covered uh that did the chapter last week on
Nick and Zach the book is called richer wiser happier how the world's greatest investors win in markets and life the author William green listened to the episode and he loved it a bunch of my friends have bought that book this week I will leave a link down below if you buy the book using that link you'll be supporting the podcast at the same time that is 365 books down 1,000 to go and I'll talk to you again soon