Table of Contents
Discover the investment philosophy that generated $2 billion in returns through Nick Sleep's partnership letters. Learn about "scale economies shared," the power of honestly run compounding machines like Costco and Amazon, and why the best investors think like entrepreneurs who never sell their best businesses.
Key Takeaways
- The best investors aren't investors at all—they're entrepreneurs who never sold their businesses, which explains why concentration beats diversification for exceptional returns
- "Scale economies shared" was Nomad's earned secret: companies that pass cost savings back to customers (like Costco and Amazon) create virtuous cycles of growth and customer loyalty
- Honestly run compounding machines have three characteristics: low operating costs, competitive wholesale prices, and high revenues that get reinvested to benefit customers rather than extracted as profits
- The biggest investment mistake is selling great companies too early—firms have lost more from selling IBM in the 1950s and Walmart in the 1970s than from any bankruptcy
- Long-term thinking provides massive advantages because cause and effect don't "sit on top of each other"—price cuts may hurt quarterly results but create enormous long-term value
- Concentration in "super high-quality thinkers" makes more sense than diversification when you can only truly know a few businesses deeply
- Cultural commitment to principles (like everyday low pricing) must be absolute—"if I let you do it this one time, you'll do it again" as Jim Sinegal warned
- The same business model that built Ford's empire 100 years ago built Walton's, Kelleher's, and Bezos's empires—these principles are timeless and transferable
The Evolution of an Earned Secret
Reading Nick Sleep's letters chronologically reveals the fascinating evolution of a deep insight that would generate $2 billion in returns. In 2002, Sleep began noticing something unusual about Costco's business model—a company that seemed to deliberately keep its margins low while obsessing over operational efficiency. At this early stage, he didn't yet understand the profound implications of what he was observing.
The breakthrough began with Sleep's analysis of Jim Sinegal's leadership philosophy at Costco. When the company secured an exceptional deal on 2 million pairs of designer jeans for $22 each (instead of the usual $32), a buyer suggested taking a higher margin since "no one would know." Sinegal's response became legendary: "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 wasn't just about pricing strategy—it revealed a fundamental business philosophy that Sleep would call "scale economies shared." As he observed: "Most companies pursue scale efficiencies; few share them. It's the sharing that makes the model so powerful. The company grows by giving back."
The parallel to Walt Disney's approach was striking. When building Disneyland under extreme time and budget pressure, an employee suggested cutting corners on leather straps for stagecoaches, arguing that "people are never going to appreciate all the close-up detail." Disney's response echoed Sinegal's: "You're being a poor communicator. People are okay, don't you ever forget that. They will respond to it, they will appreciate it."
Both leaders understood that organizational culture depends on absolute commitment to core principles. Compromise once, and the entire system begins to erode. As Sleep noted: "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 firm's genesis."
Sleep's insight deepened as he recognized that Costco's approach created a "perpetual motion machine." Lower costs enabled lower prices, which attracted more customers, which generated more scale, which enabled even lower costs. The virtuous cycle was self-reinforcing and incredibly difficult for competitors to break.
By 2004, Sleep had identified this as one of the few investment models that consistently worked: "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."
The breakthrough moment came when Sleep realized this model could be "superpowered" by the internet. After extensively analyzing Costco's physical retail advantages, he wrote: "Costco has some of these attributes... but it's not the lightest of them all. For that one must turn to the internet." Initially, he thought this meant eBay, but he would soon discover that Amazon represented the perfect digital embodiment of scale economies shared.
What made this an "earned secret" rather than just an observation was Sleep's willingness to build his entire investment strategy around this single insight. As he later reflected: "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."
This evolution from observation to insight to organizing principle demonstrates how the most valuable investment ideas often emerge gradually through deep, sustained analysis rather than sudden revelations.
Honestly Run Compounding Machines
Sleep's most valuable contribution to investment thinking was his framework for identifying what he called "honestly run compounding machines"—businesses that could compound value for decades while maintaining their competitive advantages. His definition was precise: companies run by leaders who chose to do the right thing for customers not because they had to, but because they wanted to.
As Sleep explained: "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." This distinction was crucial because companies forced into good behavior by competition or regulation could revert to extractive practices when circumstances changed.
The "honestly run" component was as important as the "compounding machine" element. Sleep observed countless businesses with strong economics that were undermined by management teams focused on short-term extraction rather than long-term value creation. The key was finding leaders with what one founder described as "an internal compass with True North pointing to what was right for the customer."
Sleep identified three essential characteristics of these businesses. First, operating costs had to be extremely low—"measured in basis points" as he noted about Costco's paranoid cost control. Second, wholesale prices needed to be as competitive as possible, achieved through disciplined supplier relationships and limited SKU counts. Third, high revenues had to be reinvested in customer benefits rather than extracted as excess profits.
The supplier relationships at Costco exemplified this approach. The company limited stores to 4,000 SKUs and auctioned shelf space to suppliers offering the best customer value. Their vendor requirements stated bluntly: "We expect all vendors to consistently and voluntarily quote the lowest possible acquisition price 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."
Sleep's response to this policy was telling: "Good grief, one strike and you're out." This wasn't negotiation—it was a system designed to ensure that scale benefits flowed to customers rather than being captured by suppliers or retained as excess margins.
The compounding element came from the virtuous cycle this created. As Sleep observed: "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 firm's expansion into, say, Ohio, as they also gain from the decline in supplier prices. This keeps the old stores growing too."
This model created what Sleep called "lowering the probability of failure." By continuously giving value back to customers, these companies built loyalty that was extremely difficult for competitors to break. The business became anti-fragile—stronger during economic downturns when customers became more price-sensitive.
The "honestly run" aspect also meant these companies could be trusted with capital allocation decisions. Sleep developed a list of "super high-quality thinkers"—leaders 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 framework allowed Sleep to think about investing differently. Instead of constantly evaluating buy/sell decisions, he could focus on identifying great businesses early and then essentially becoming a permanent partner. As he put it: "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."
Amazon: The Digital Embodiment of Scale Economies Shared
Sleep's analysis of Amazon represents one of the most prescient investment cases ever documented. Writing in 2006 when Amazon's market cap was just $18 billion (compared to eBay's $77 billion), Sleep recognized that Amazon represented the digital perfection of the scale economies shared model he had identified at Costco.
The timing of his analysis was remarkable. Most investors viewed Amazon as a struggling retailer that might never become profitable, while eBay was considered the clear winner in e-commerce. But Sleep saw something others missed: Amazon was applying the same customer-first philosophy that had made Costco successful, but with the additional advantages of internet scale and capital efficiency.
Sleep's breakthrough came from studying Jeff Bezos's shareholder letters, where he found the philosophical framework that would guide Amazon's long-term strategy. Bezos had written: "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."
This was exactly what Sleep had observed at Costco, but Bezos articulated the long-term thinking more explicitly: "When we lower prices, we go against the math, which always says that the smart move is to raise prices... However, our quantitative understanding of elasticity is short-term. We can estimate what a price reduction will do this week and this quarter, but we cannot estimate the effect that consistently lowering prices will have on our business over five or 10 years."
Sleep immediately recognized this as the same earned secret he had discovered through Costco analysis. His response to Bezos's explanation was simply: "Amen." He then added: "I think Bezos would run a good investment fund, but that is the point—good investing and good business decisions are synonymous."
The Amazon analysis also revealed Sleep's understanding of internet economics. He noted 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." The winner-take-most dynamics of digital markets meant that Amazon's scale economies shared model could create even more dramatic competitive advantages.
Sleep's conviction deepened as he observed Amazon's performance during the 2008 financial crisis. While traditional retailers saw sales decline 10%, Amazon's order volumes grew 16% year-over-year on their busiest day. This demonstrated that the scale economies shared model was "anti-fragile"—it actually performed better during economic stress when customers became more price-sensitive.
The investment required enormous conviction because the market was pricing Amazon "as if it would not grow in the future, despite some of the best growth prospects we can imagine." Sleep had to trust his analysis of Amazon's business model over the market's short-term pessimism about profitability.
Perhaps most remarkably, Sleep recognized that Amazon's total addressable market was vastly larger than most investors understood. In 2006, e-commerce represented just 3.1% of total retail sales. Sleep asked: "What do you think e-commerce will be as a proportion of US retailing in 10 years' time?" His implicit answer was that Amazon was still in the very early stages of a multi-decade growth opportunity.
This analysis led to one of the most concentrated investment positions in modern history. By the end of Nomad's life, Zak Ashkar had 70% of his net worth in Amazon stock—a level of concentration that would have seemed reckless to most investors but made perfect sense given their conviction about Amazon's business model and total addressable market.
The Psychology of Holding vs. Selling
Sleep's most profound insight about investing psychology was his observation that "the best investors aren't investors at all—they're entrepreneurs who never sold." This wasn't just a clever aphorism; it revealed a fundamental difference in how entrepreneurs and professional investors think about great businesses.
Entrepreneurs like Sam Walton, Bill Gates, and Jeff Bezos held their companies for decades not because they were making calculated investment decisions, but because they were building something meaningful that served customers. They weren't optimizing for the best financial return; they were focused on creating long-term value, which paradoxically led to the best financial returns.
Sleep illustrated this principle through the story of a Baltimore fund management company that made two catastrophic mistakes. In the 1950s, they sold their IBM holdings, which went on to appreciate so much that the value of the shares sold eventually exceeded the entire value of the fund management company. Having learned from this "mistake," they then sold their Walmart holdings in the 1970s, which 30 years later were worth more than their total funds under management.
The pattern wasn't unique to this firm—it represented a systematic problem in professional investing. As Sleep noted: "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 we get from our clients."
The psychological challenges were immense. After Amazon doubled, Sleep wrote: "It'd be easy for Zack and me to claim victory, high five, and sell our shares in Amazon... We wonder, would selling Amazon today be the equivalent mistake of selling Walmart in 1980?"
Sleep understood that selling great companies too early wasn't just about missing returns—it revealed a fundamental misunderstanding of how great businesses work. Most investors focused on stock prices and quarterly results rather than the underlying business reality. They couldn't see success when it was happening because they were looking at the wrong metrics.
The solution was to focus on what Sleep called "the central engine of success" rather than financial outputs. For Walmart, this was "a thrift orientation—low costs, low waste, fueling growth with the savings shared with the customer." For Amazon, it was the customer-centric culture that prioritized long-term value creation over short-term profitability.
Sleep also recognized that holding great companies required dealing with volatility and criticism. During the 2008 financial crisis, when Amazon's stock declined dramatically, Sleep wrote: "I know it doesn't seem like it, but I promise you this is the best possible time to be an investor." He could see that Amazon's business fundamentals were actually strengthening while the stock price declined.
The key insight was that temporary stock price volatility was the price you paid for permanent ownership of great businesses. As Sleep put it: "Time is a friend of the wonderful business and the enemy of the mediocre." Patient investors who could tolerate short-term volatility while focusing on long-term business strength would be rewarded with extraordinary returns.
This required what Sleep called "the aggregate patience of the investor base." Nomad structured itself as an investment partnership rather than a traditional fund precisely to attract investors who shared this long-term orientation. As Sleep wrote: "Only by looking further out than the short-term crowd can we expect to beat them."
Concentration vs. Diversification: The Knowledge Argument
Sleep's approach to portfolio concentration was based on a deceptively simple insight: you can only truly know a few businesses deeply, so concentration in your best ideas makes more sense than diversification across many mediocre ones. This wasn't just about generating higher returns—it was about reducing risk through deeper knowledge.
As Sleep explained: "If knowledge is a source of value and few things can be known for sure, then it logically follows that owning more stocks does not lower risk but raises it." The conventional wisdom about diversification assumed that spreading investments across many holdings reduced risk, but Sleep argued this was only true if you didn't have genuine insights about specific businesses.
The "few things can be known" principle came from Charlie Munger's approach to investing. During their dinner together, Munger told Sleep that "being good at investing is a very rare skill—it is not distributed widely and will never be." The rarity came from the enormous amount of work required to truly understand any business deeply enough to make confident long-term predictions.
Sleep illustrated this with his research process: "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." From this massive effort, they found very few businesses they felt confident enough to own meaningfully. The opportunity cost of this research was enormous, which made concentration in the best ideas even more logical.
The evolution of Nomad's thinking on concentration was visible throughout the letters. In 2004, their largest position was just 7% of the portfolio, with holdings ranging down to 3%. Sleep was already questioning this approach: "The issue then is how much to invest in each idea... In reality, opportunities in which we are comfortable to deploy capital are rare, and the highest conviction idea is the rarest of them all."
By referencing the Kelly Criterion, Sleep showed that mathematical approaches to position sizing also supported concentration: "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?" His answer was illuminating: "As far as we are aware, only the early Buffett partnership portfolios had anyone near this level of concentration."
Sleep's "terminal portfolio" concept represented the logical endpoint of this thinking. He maintained a list of "super high-quality thinkers"—companies whose shareholders could "abdicate their right to trade stock, sure in the knowledge that their capital will be well allocated for years to come." The question he posed was fundamental: "Why is this list not the same as the current Nomad portfolio?"
The answer revealed the gap between intellectual conviction and practical implementation. Sleep knew which businesses deserved concentration, but psychological and institutional pressures made it difficult to act on that knowledge. The gradual evolution toward heavy concentration in Costco, Amazon, and Berkshire represented Sleep's growing confidence in his analytical framework.
The knowledge argument also explained why Sleep preferred to hold businesses forever rather than trading in and out. Each sale required a new decision about capital allocation, which introduced the possibility of error. As Sleep noted: "Each day Buffett chose not to do anything was a decision taken too, and arguably more difficult than to do something because I think we are naturally wired to do something, to take action."
The ultimate validation of this approach came through the results. By the end of Nomad's life, Zak Ashkar had 70% of his net worth in a single stock (Amazon), while Sleep maintained massive positions in just three companies. This level of concentration would have seemed reckless to most investors, but it made perfect sense given their deep knowledge of these specific businesses and confidence in their long-term prospects.
The Timeless Business Model
One of Sleep's most profound insights was recognizing that certain business models transcend time and industry boundaries. The same fundamental approach that built Henry Ford's empire in the 1900s, Sam Walton's in the 1970s, Herb Kelleher's in the 1990s, and Jeff Bezos's in the 2000s would continue building empires in the future.
The core model was elegantly simple: achieve the lowest possible costs, pass those savings to customers in the form of lower prices, use the resulting growth to achieve even greater scale and lower costs, and repeat the cycle indefinitely. What varied was the specific industry application and technological context, but the fundamental customer-centric philosophy remained constant.
Ford's assembly line enabled mass production that dramatically lowered automobile costs. Instead of keeping these savings as higher margins, Ford passed them to customers through lower prices, making cars affordable for ordinary workers. This created the mass market that justified even greater scale and further cost reductions.
Walton applied the same principle to retail, using technology and logistics to achieve lower costs than competitors, then sharing those benefits with customers through "everyday low prices." The resulting customer loyalty and volume growth enabled further investments in technology and scale, creating a virtuous cycle that competitors couldn't match.
Kelleher revolutionized aviation by eliminating unnecessary costs (hub-and-spoke routing, complex fare structures, expensive airports) and passing the savings to customers through dramatically lower fares. This democratized air travel while building Southwest into the most profitable airline in history.
Bezos took the model digital, using Amazon's scale to negotiate better terms with suppliers, invest in logistics infrastructure, and continuously lower prices for customers. The internet's winner-take-most dynamics amplified the model's effectiveness, enabling Amazon to achieve dominance across multiple categories.
Sleep's insight was that this wasn't just about pricing strategy—it reflected a fundamental philosophy about the purpose of business. Leaders who truly understood the model weren't optimizing for short-term profits; they were building long-term customer relationships that would compound over decades.
The model's power came from its alignment with basic human psychology. As Sleep observed: "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... The reason you have these feelings and the stimuli that produce them have hardly changed in millennia."
This timeless quality made the model particularly valuable for long-term investors. Unlike technological advantages that could become obsolete or regulatory moats that could be eliminated, customer loyalty based on consistently superior value propositions was remarkably durable.
The model also explained why competing against these companies was so difficult. Traditional competitors focused on maximizing margins and quarterly profits, which meant they couldn't match the pricing of companies committed to sharing scale economies with customers. The result was a gradual market share transfer that could continue for decades.
Sleep's application of this insight to investing was powerful because it provided a framework for identifying future winners across different industries. Instead of trying to predict which specific technologies or business models would succeed, he could look for leaders who understood and were implementing the timeless principle of customer-centric value creation.
The model's universality also suggested practical applications beyond investing. Any business could potentially implement these principles by obsessing over operational efficiency, sharing the benefits with customers through better value propositions, and using the resulting growth to fund further improvements.
Selected Quotes and Insights
"The best investors aren't investors at all—they're entrepreneurs who never sold."
This insight explains why concentration beats diversification for exceptional returns. Entrepreneurs like Sam Walton and Jeff Bezos held their companies for decades not because they were making calculated portfolio decisions, but because they were building something meaningful. The emotional attachment to their life's work paradoxically led to better financial outcomes than purely analytical investment approaches.
"Most companies pursue scale efficiencies; few share them. It's the sharing that makes the model so powerful. The company grows by giving back."
This captures the essence of Sleep's "earned secret"—the recognition that businesses which pass cost savings to customers create virtuous cycles of growth and loyalty. While most companies extract scale benefits as higher margins, the most successful companies use them to build competitive moats through customer relationships.
"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."
Sleep understood that truly valuable insights are extremely rare and should be treated accordingly. Rather than diversifying across many mediocre ideas, he concentrated heavily on the few business models he understood deeply. This principle applies beyond investing to any domain where deep insights can create sustainable advantages.
Conclusion
Nick Sleep's letters reveal how exceptional investment returns come not from trading activity or complex strategies, but from identifying and holding "honestly run compounding machines" for extended periods. His earned secret—that companies sharing scale economies with customers create unstoppable competitive advantages—enabled him to recognize Amazon's potential when its market cap was just $18 billion and most investors viewed it as a struggling retailer. Sleep's approach required enormous psychological discipline: concentrating in just a few businesses, holding through volatility, and thinking in decades rather than quarters. Most importantly, he understood that the same business model that built Ford's empire 100 years ago continues building empires today, making these insights timeless and transferable to any business focused on creating long-term customer value.
Practical Implications
- Focus on understanding the "central engine of success" in any business rather than just financial metrics or stock price movements
- Look for companies that pass scale benefits to customers rather than extracting them as excess margins—these create the strongest competitive moats
- Concentrate investments in the few businesses you understand deeply rather than diversifying across many mediocre opportunities
- Establish absolute commitment to core principles in your organization—compromise once and the entire culture begins to erode
- Think in terms of decades rather than quarters when making important business decisions—cause and effect rarely "sit on top of each other"
- Study great businesses and business models from history to identify timeless principles that transcend specific industries or time periods
- Build organizations around customer value creation rather than short-term profit extraction—this paradoxically leads to better long-term financial results
- Develop systems that measure and reward long-term customer satisfaction rather than just short-term financial performance
- Accept that holding great investments through volatility requires more psychological discipline than active trading strategies
- Remember that the biggest mistakes often come from selling great companies too early rather than from holding mediocre ones too long
