A letter a day!

A letter a day!

Letter #03 2003

Key learnings:

1.The partnership started investing in unlisted space from this year. The first investment being ,Weetabix Limited, a manufacturer of cereals and Bars in U.K.

2.The course of the market will determine, to a great degree, when we will be right (the sequence of annual outcomes), but the accuracy of our analysis of the company will largely determine whether we will be right. In other words, we tend to concentrate on what should happen rather than when it may occur.

3.Quality of managerial character is important to avoid capital misallocation.

4.Value creation is often most sustainable when it is built slowly.

5.As investors, winners flatter our ego regardless of the reason they went up, whilst we all feel bad about the losers.

6.Some principles applied in managing nomad partnership:

1)The reason, of which the firm is certain of the performance, is the decline in the level of fear felt by other investors.

2)The aim is to make investments at prices that is fifty cents on the dollar of what a typical firm is worth.

“Capital allocation by investee companies must be consistent with value creation and, if this is the case, we expect that the real value of the business (the 100 cents value) could grow at around 10% per annum. The effect over five years will be to compound U$1 of value into U$1.62, and companies that can build value like this are normally rewarded in the market with a fair valuation (i.e., are priced close to U$1.62). This happy outcome would imply a return from purchase price (50 cents) of around 26% per annum”

3)The most common mistake is to misjudge capital allocation decisions by the companies: firms which articulate a share repurchase/debt repayment strategy and have incentives to reinforce that outcome, throw caution to the wind and make acquisitions instead.

“The Partnership’s investment in Readers Digest falls into this category. Capital allocation mistakes such as these often prevent the compounding of value but to date have rarely resulted in a permanent decline in the share price to below our purchase price (50 cents). We have therefore tended to find that our mistakes atrophy (stay cheap) rather than collapse, although we can all name one collapse!”

4)The prime determinants of outcome are price (sticking to 50 cents on the dollar) and capital allocation by management. The first is in our control, that is, it is in our control to be patient and wait for the right price. The second involves a subjective judgment about the quality of management, and an assessment about the sustainability of business returns in the long run.