The Twin Engines of Increased Conviction: A Framework for Long-Term Investing
Harnessing the knowledge flywheel for companies that get stronger over time
Dear Reader: Welcome to this post, and if you are new here, welcome to my newsletter! Not so long ago, I found myself listening to a podcast that reviewed Nomad Partnership's performance over the years and their particular philosophy. At the same time, I was reading some other books with similar concepts. This post is the result of connecting the dots if you will, and intends to fine-tune my investment philosophy. Hopefully, you will enjoy it as much as I enjoyed writing it. But first, below there is a companion audio I’m experimenting with that you can listen to set the stage before reading. That’s it, let's dive in!
"The desire to perform all the time is usually a barrier to performing over time."
- Robert Olstein
Your inbox is full with financial newsletters, each promising the next "criminally undervalued" gem. You've seen it all before - the "deep dives," the breathless write-ups, the siren song of easy riches, yes I’ve read more of those that I can easily count. But let's be honest - how much of this truly provides deep understanding? Or does it merely add to the noise, clouding your judgment as an investor?
Now, what’s the alternative? How about owning a stake in one of the great businesses of our time? A business that doesn't just grow - it becomes better year after year: not only growing its revenues but becoming more profitable and fortifying its moat.
Which scenario resonates more? If you're drawn to the latter, you may find value in an investment approach that combines the power of compounding business strength alongside the compounding of investor knowledge—a framework driven by what I call the "twin engines of increased conviction."1
By embracing this approach, your decision-making sharpens. Market volatility fades into background noise and true, lasting wealth creation becomes not just possible - it becomes inevitable.
So, why aren't all investors embracing this approach? The usual suspects are well-known:
Misaligned incentives
Lack of discipline
Chronic impatience
Superficial analysis
But there's also a less obvious, yet equally detrimental factor at play: 'investment snacking', a phenomenon that Pulak Prasad aptly describes in his book “What I Learned About Investing From Darwin”.2
Is ‘Investment Snacking’ Hurting Your Portfolio?
‘Investment snacking’ is defined as the habit of making frequent, impulsive investment decisions without thorough research or a long-term strategy.
You might ask, "What's the problem with this approach?" Well, there are many issues which some of them being:
Lack of commitment
Surface-level understanding
Emotional decision-making (FOMO, anyone?)
Diminished satisfaction
And most critically, a shortage of conviction
These factors combine to create a perfect storm of suboptimal returns. The consequences? You end up having wealth erosion over time, increased stress and anxiety, and you miss the opportunity to enjoy seeing a well-researched investment thesis play out over time.
Some people call it ‘the permanent tourists of the stock market’, always skimming the surface of new destinations but never truly experiencing the depth of any single place.
Yet, amidst this perfect storm, a beacon of excellence emerges: the path of focused mastery. This approach advocates doing fewer things, but executing them with unrivalled precision and depth. Let's take a brief detour in the story of Jiro Ono, the sushi maestro.
From Rice to Riches: Jiro's Lessons for Investors
Tucked away in a Tokyo subway station, there’s a tiny, 10-seat sushi restaurant. It's not much to look at, but it has three Michelin stars and a months-long waiting list. Behind the counter stands Jiro Ono, a man who has been perfecting the art of sushi for over 75 years.
In 2011, David Gelb's documentary "Jiro Dreams of Sushi" catapulted this culinary legend into the global spotlight. So much so, that even Obama went there in 2014 while he was still president.
So what's Jiro's secret? An unwavering focus and dedication to his craft. Every grain of rice, every slice of fish, every movement of his hands has been refined over decades of relentless practice. Jiro is not interested in French cuisine or in experimenting with molecular gastronomy. He makes sushi, and he makes it better than anyone else on the planet.
Can you apply Jiro's philosophy to your own investment process? Indeed, some successful investors already have.
Sleep & Zakaria: One Thing, Done Well
Nick Sleep and Qais Zakaria, the founders of the legendary Nomad Investment Partnership, embraced this philosophy: focus on doing one thing exceptionally well.
Their approach is may be more reminiscent of Robert Pirsig's "Zen and the Art of Motorcycle Maintenance" - a deep, almost meditative focus on understanding and mastering a single subject.
Probably, you could condense this approach with the following principles:
Select a handful of high-quality businesses
Study these companies with monastic dedication
Hold positions for the long term, allowing compounding to work its magic
This strategy isn't about chasing the next big thing, no snacking here. Instead, it's about becoming an expert on a select few companies, giving you an edge that few other investors can’t match.
You can already see where I’m going here…
The Twin Engines of Increased Conviction
“Take a simple idea and take it seriously.”
—Charlie Munger
I've always been a fan of two principles that I try to apply to investing: (1) "Know thyself"; and (2) always, always try to turn the odds in your favor.
As a fundamental investor, how can you decisively tilt the odds in you favor? The answer, I believe, lies in what I call the "Twin Engines of Increased Conviction":
Deepening Knowledge Over Time: The longer you hold and study a company, the more you understand its nuances, management, and industry dynamics.
Strengthening Competitive Position: Focus on businesses that actually improve their competitive stance as they grow. This is where the genius of Nick Sleep and Qais Zakaria comes into play. They've identified a specific type of business model that perfectly aligns with this philosophy: companies with scale economics shared.
So there it is: select companies that improve over time and study them deeply. Sounds simple, doesn't it? Well, I think it is a simple yet powerful idea. This flywheel enhances your competitive advantage as an investor over time. You increase your conviction BECAUSE you know the business better, but also BECAUSE the business itself improves as it grows.
I acknowledge that you can only apply the twin engines to companies that improve over time (mind the subtle difference with companies that grow over time). It's not enough to find companies with moats; these moats must grow bigger and stronger as the company expands. Moreover, the strengthening of the moats should be the direct result of this growth.
Knowing that you have limited time and attention, you put the odds on your favour by focusing on fewer companies. You devote your time to truly understand their business models, competitive advantages, and long-term growth prospects. The more you learn, the more your conviction grows, allowing you to make informed decisions with greater confidence.
As these businesses continue to grow, their competitive advantages improves, creating an increasing gap between them and their competitors. This compounding strength not only improves the company's long-term prospects but also reinforces your conviction as an investor.
I believe that, together, these twin engines improve your odds of success over time.
Above all, this synergy allows increased conviction. As you learn more, and as the business grows stronger, your confidence in the investment thesis solidifies, allowing you to make better decisions, to hold through periods of market volatility and, ultimately leading to superior long-term returns.
Now let's delve deeper into the underlying principles of each engine.
Engine №1: Deepening Knowledge Over Time
Let's examine two fundamental concepts that, I believe, underpin Engine №1: the value of time and attention, and the exponential curve of knowledge acquisition.
The Value of Time and Attention
Time and attention are the raw materials from which deep understanding is forged. Unlike capital, which can be replenished, time is finite and irretrievable. How you allocate this scarce resource can have a huge impact in the depth of knowledge you acquire.
Somewhere in past articles, I played with the idea of Return on Attention, another type of ROA. The question then becomes: How can you maximize the ROA of your investment analysis process? I’d say at least one should:
Focus on High-Quality Information: Prioritize primary sources. Quality of information trumps quantity every time.
Create a Systematic Research Approach: Develop a structured method for analyzing companies, industries, and macroeconomic trends. This ensures consistency and helps identify patterns over time.
Implement a Personal Knowledge Management System: I use tools like note-taking apps or personal wikis to organize and retrieve accumulated knowledge. This transforms isolated facts into an interconnected web of investment insights.
Cultivate a Multidisciplinary Approach: Draw insights from various fields like psychology, technology, and history to enrich your understanding of businesses and markets. This cross-pollination of ideas can uncover unique investment approaches and opportunities (as we strive to demonstrate in this humble newsletter).
Above all, if you want to maximize your return on attention, then you should leverage the exponential curve of knowledge acquisition.
The Exponential Curve of Knowledge Acquisition
Knowledge acquisition in a focused domain follows an exponential curve. Initially, progress may seem slow as you build a foundational understanding. However, as your expertise deepens, each new piece of information yields greater insights, accelerating your learning.
This exponential growth in knowledge creates a widening gap between you and less focused investors. Over time, this knowledge disparity can translate into a significant edge in identifying unique investment opportunities, managing risks more effectively, and generating alpha.
Let’s take a look at what Kobe had to say in relation to this:
If you engage in ‘investment snacking’ - hopping from one special situation to another or investing in "OK" companies while waiting for them to reach "fair value" - you're constantly starting over with each new investment idea. While there are undoubtedly successful investors employing this strategy, my goal is to maximize the odds of success, which would then suggests avoiding this approach. Imagine if Kobe were training for basketball one year, tennis the next, and baseball the following (MJ tried that last one and didn’t go that well).
Think of a graph where the x-axis represents time and the y-axis represents depth of knowledge. For most investors, this graph would show multiple short, steep curves as they jump from one company to another. But for those following the Engine №1 approach, it's one long, exponential curve that keeps climbing higher.
Again, it’s exponential NOT linear.
The "More You Know, The More You Know" Phenomenon And The “Cognitive Load Theory”
This exponential growth in knowledge isn't just a theory - it's a well-documented psychological phenomenon. The more you learn about a subject, the more "mental hooks" you create to hang new information on. This leads to:
Faster assimilation of new data
Better pattern recognition
More nuanced understanding of complex situations
Increased ability to spot anomalies or opportunities
Think of it like compound interest for your brain. Each piece of knowledge you acquire makes the next piece easier to understand and integrate into your mental model.
I borrow some ideas here from the Cognitive Load Theory (CLT), a model introduced by John Sweller in the 1980s, CLT is based on a simple premise: our working memory has limits.
The theory identifies three types of cognitive load: intrinsic (the inherent complexity of the material), extraneous (unnecessary mental effort caused by poor instruction), and germane (the good kind of mental effort that leads to learning). The goal? Minimize the extraneous, manage the intrinsic, and maximize the germane.
Let's explore each one in more detail.
*more on schemas below.
Remember, you want to maximize germane load. More examples of activities that increase germane load are a) Comparing a new company's business model to familiar ones, noting similarities and differences b) Creating a mental map of how different parts of a business interact c) Explaining a company's competitive advantage in your own words.
I wrote more on this in the article below:
Ok, this is fine an well to start the research process on a company and accelerate understanding. But CLT tell us something else: the idea of schemas.
Schemas are mental frameworks that act as cognitive shortcuts, allowing you to chunk information and process it more efficiently, they are basically organized thought patterns that categorize information and relationships between data. The more schemas you develop about a company, the more effortlessly you can learn new, related information.
Schemas main utility, is that they help you reduce cognitive load. The brain, constantly striving for efficiency, uses these mental frameworks to streamline information processing and decision-making in complex environments.
So what are the benefits of having developed schemas about a specific topic? Let’s see:
Schemas enable the grouping of related pieces of information, allowing complex company data to be treated as a single unit in working memory. This cognitive strategy effectively expands the capacity of working memory, enabling you to process larger amounts of interconnected financial information simultaneously.
Schemas help direct your attention to the most relevant information, reducing the cognitive load of sifting through all available data. This allows you to efficiently extract key information without being overwhelmed by the volume of data.
Schemas provide a framework for comparing new information with existing knowledge, making it easier to identify similarities, differences, and anomalies.
Schemas in Action: An Example of Engine №1 Firing on All Cylinders
I’ve been arguing that accumulating knowledge about a single company can lead to the development of complex schemas that generate exponential returns in understanding.
Well, let’s apply this to a specific example. Let’s use Apple for the sake of clarity. Imagine that over the years you developed the following schemas:
Now, the theory goes, you should be able to reduce your cognitive load allowing the following:
Efficient Processing of New Information:
Example: When Apple announces a new product, your extensive schema allows you to quickly assess:
Its fit within the existing ecosystem
Potential cannibalization of other Apple products
Likely impact on the supply chain
Expected effect on financial performance
Instead of analyzing these factors from scratch, your schema allows for rapid assessment.
Chunking Information:
Example: When reviewing Apple's quarterly results, instead of processing each number individually, you might chunk information into:
iPhone performance (units, ASP, regional breakdown)
Services growth (revenue, margins, subscriber numbers)
Emerging product categories (wearables, home, accessories)
This chunking allows you to hold and analyze more information simultaneously.
Filling in Gaps:
Example: If Apple doesn't break out Apple Watch sales figures, your schema allows you to:
Estimate sales based on growth in the Wearables category
Infer market reception from supply chain reports
Gauge success from mentions in earnings calls
Guiding Attention:
Example: During Apple's WWDC (developer conference), your schema guides you to pay attention to:
New features that could drive hardware upgrades
Changes to App Store policies that might affect Services revenue
Technologies that could lead to new product categories
This focused attention reduces the cognitive load of processing hours of presentations.
Facilitating Comparisons:
Example: When analyzing a new iPhone release, your schema allows you to quickly compare it to:
Previous iPhone launches and their market impact
Historical patterns of feature introductions
Past supply chain challenges and resolutions
As your Apple schema becomes more complex and interconnected, you start seeing exponential returns in the form of:
Predictive Power: You can more accurately predict Apple's moves, like potential new product categories or strategic shifts.
Holistic Analysis: You can quickly connect dots between seemingly unrelated pieces of information (e.g., a small acquisition and a future product direction).
Nuanced Interpretation: You can discern the significance of subtle changes in Apple's communications or strategies that others might miss.
Rapid Adaptation: When unexpected events occur (like a pandemic), you can quickly assess the multifaceted impacts on Apple's business.
Efficient Learning: Each new piece of information about Apple is rapidly integrated into your existing schema, enhancing your overall understanding with minimal cognitive effort.
Imagine you own a smaller, less followed company. You've developed dozens of schemas related to different aspects of the company, you keep nurturing and nourishing those connections over the years. At the end of the day, your deep, nuanced understanding becomes an insurmountable information advantage over other investors.
Ok, hopefully by now, I proved you that by harnessing the power of Engine №1 - Deepening Knowledge Over Time - you set the stage for more confident (and potentially more profitable) investment decisions.
But, what about Engine №2?
Engine №2: Strengthening Competitive Position
The second engine that plays a part in increasing conviction is the inherent ability of exceptional businesses to strengthen their competitive position over time as they grow. This goes beyond merely thinking about "compounders with a moat"; it focuses on businesses whose moat not only exists but becomes increasingly formidable as they scale.
Having a moat is better than not having one, but if you don't have reinvestment opportunities inside your moat, your company will have to do something with the cash.
Even if you DO have reinvestment opportunities inside your moat, that doesn't mean that your competitive position will get stronger, it just means that your business will be bigger, (attracting more competitors) and you'll have the same moat.
Having more smart people attacking your moat is not fun. This situation can indeed end up eroding your competitive advantage, reducing your Competitive Advantage Period (CAP), and causing returns to revert to the mean.
What do you do if you want to always put the odds in your favor as an investor, if you want to buy to never sell, and if you want to maximize your returns on attention to improve your edge against other investors? Enter Engine №2.
At the heart of this engine lies a powerful concept, as described by Sleep and Zakaria in their Nomad letters: scale economics shared.
Perpetual Motion Machines: Defining Scale Economics Shared
Scale economics shared refers to a business model where a company passes on the benefits of increasing scale and efficiency to customers in the form of lower prices. This creates a virtuous cycle - lower prices lead to more customers and sales, which allows for greater scale and efficiency, which can then be passed on as even lower prices.
Companies that follow this approach focus on a long-term orientation and willingness to sacrifice short-term profits for long-term market dominance.
As Jeff Bezos put it:
“Our first shareholder letter, in 1997, was entitled, “It’s all about the long-term”. If everything you do needs to work on a three-year time horizon, then you’re competing against a lot of people. But if you are willing to invest on a seven-year time horizon, you’re now competing against a fraction of those people, because very few companies are willing to do that. Just by lengthening the time horizon, you can engage in endeavours that you could never otherwise pursue. At Amazon we like things to work in five to seven years. We’re willing to plant seeds, let them grow – and we’re very stubborn. We say we are stubborn on the vision and flexible on the details”.
Sleep believes this model creates a deep and widening moat around a business as it grows larger, making it very difficult for competitors to catch up. He sees it as a key factor in identifying businesses that can compound value over very long periods of time.
By focusing on companies that exhibit these characteristics, you can align yourself with businesses that have an inherent tendency to strengthen their market position over time. This forms the core of Engine №2 in the twin-engine approach.
Ok, I have discussed the characteristics of the two engines. Now, how can you implement this framework. Let’s see.
Practical Implementation for Investors
Now that you understand the power of the twin engines, let's explore how to put this knowledge into practice. I hope this section will provide you with actionable strategies to implement this approach in your own investment process and in doing so, I apologize in advance, as I will dive deeper in the Nomad Investment Partnership Letters to Partners to provide clear examples of each characteristic of the model. But first, let’s discuss Engine №1.
Developing a Research Process
To harness Engine №1 (Deepening Knowledge Over Time), develop a systematic research process. Some of this best practices I’ve already mentioned above:
Implement a Personal Knowledge Management System: Use tools like Notion, Obsidian, Anytype or mymind to organize and easily retrieve your accumulated knowledge.
Create a Research Checklist: Develop a standardized list of questions to answer for each company you analyze. This ensures consistency and comprehensiveness in your research.
Use Primary Sources: Prioritize annual reports, earnings call transcripts, and industry publications over secondary analyses.
Develop an Industry Framework: For each industry you invest in, create a framework that outlines key success factors, potential disruptors, and important metrics.
Create a Monitoring System: Develop a system to track key metrics and news for your focus companies and their competitors.
Implement a Decision Journal: Record the reasoning behind each investment decision, you can use tools like Journalityc. Review these often to improve your decision-making process.
Identifying Businesses with Scale Economics Shared
To find companies that benefit from this model, look for the following indicators:
Consistently declining prices: Look for companies that have a track record of lowering prices over time, even as their business grows. This shows they're passing on scale benefits to customers. In December 2004 letter, Sleep discuss Costco strategy in this regard:
"Costco Wholesale is a member-only wholesaler of consumer goods. Membership is available to the public at a price of U$45 per annum. The act of purchasing membership has the effect of raising the company's share of mind with the customer in the same way that consumer goods companies hope to achieve with conventional advertising. At Costco, the consumer has chosen to commit to the retailer. In other words, people shop at Costco because it is Costco, not because Costco stocks Coke. And the reason they shop is that goods are priced at a fixed maximum 14% mark up over cost. The fixed mark-up is referred to in the industry as "every-day-low-pricing" or EDLP, in order to differentiate it from normal industry practice of changing prices in an attempt to influence traffic, or so-called high-low pricing. At Costco the consumer pays no more than 14% over what the company paid, period."
"To understand how important EDLP is to Jim Sinegal, the firm's founder, consider the following story which was recounted to us by a company director. Costco bought 2m designer jeans from an exporter and shipped them into international waters and re- imported the jeans for an all-in price of U$22 or so per pair. This was U$10 less than the firm had sold the jeans for in the past (offering the potential for a 50% mark-up) and half the cost of most other retailers. One buyer recommended taking a higher gross margin than was usual (i.e., more than the usual 14% mark-up) as no one would know. Apparently Sinegal insisted on the standard mark up, arguing that if 'I let you do it this time, you will do it again'."
Or even on the Jeff Bezos quote:
“As our shareholders know, 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. In fact, when we lower prices, we go against the math that we can do, 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 units sold of a certain percentage. With rare exceptions, the volume increase in the short-term is never enough to pay for the price decease. 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 numerically estimate the effect that consistently lowering prices will have on our business over five years or ten years. Our judgment is that relentlessly returning efficiency improvements and scale economies to customers in the form of lower prices creates 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.com. We have made similar judgments around Free Super Saver Shipping and Amazon Prime, both of which are expensive in the short term and – we believe – important and valuable in the
long term.”
Rising market share: These businesses should be gaining market share over time as their value proposition improves relative to competitors.
Customer-centric culture: Look for companies whose founders and leaders consistently emphasize customer value over short-term profits in their communications and actions.
Reinvestment in the business: These companies often have high levels of capital expenditure as they continuously invest in improving efficiency.
Low profit margins but strong cash flows: They may operate on thin margins, but should generate strong cash flows due to their scale and efficiency. In the December 2004 letter, Sleep discusses this concept when analyzing Costco:
"So, what heuristics do investors incorrectly apply to Costco (why might the shares be mis-priced?). Heuristic One: "the company has low margins" (net profit margin is 1.7%, compared to Walmart at 3.6% and Target at 4.2%). True, but that's the point. The firm is deferring profits today in order to extend the life of the franchise. Of course, Wall Street would love profits today but that's just Wall Street's obsession with short term outcomes. Heuristic Two: "it's expensive at 24x earnings". Really? Net income is a small residual, as discussed above. The firm could earn Walmart margins by taking pricing up a little, in which case the firm would be on 11x earnings, but would it be a better business as a result? We think not, if it allowed the competition to catch up."
High customer loyalty and low churn: The value proposition should result in sticky customer relationships. You could analyze customer satisfaction metrics and Net Promoter Scores (NPS) over time if the metric is available.
Founder-led or long-tenured management: This model requires long-term thinking, often embodied by founding families or long-serving executives.
Putting It All Together
Here's where the magic really happens - these two engines don't just operate independently; they reinforce each other:
As the company's competitive position strengthens (Engine №2), your deepening knowledge (Engine №1) allows you to recognize and appreciate this improvement before the broader market.
Your growing expertise (Engine №1) enables you to better assess the long-term potential of the company's strengthening position (Engine №2), potentially giving you the conviction to hold or even increase your position when others might be selling.
The longer you hold and study the company, the more both engines accelerate, creating a compounding effect on your investment edge.
In the end, true investing mastery isn't about constantly chasing the next big thing. It's about doing fewer things exceptionally well, with patience, focus, and, just as Jiro Ono, with an unwavering commitment to quality.
Chris Mayer talks about the "twin engines" of the 100 Bagger referring to growth and multiple expansion in his book: Mayer, C. W. (2015). 100 Baggers: Stocks that Return 100-to-1 and How to Find Them. Laissez Faire Books.
“My wife has a sweet tooth but is also very health conscious. Over more than two decades, she has followed a simple yet powerful way of avoiding the enticement of desserts. Our fridge just doesn’t have any. In my view, the best way to avoid investing in bad businesses is to ignore them and their stock prices. We never discuss what we consider bad companies or industries in our team meetings. Never. It doesn’t matter if an airline has declared spectacular results recently or if every analyst recommends buying airline shares. We are indifferent to a public sector bank that has hired a new CEO from the private sector and has pushed its stock price to an all-time high. We ignore an infrastructure business that has been awarded a new multibillion-dollar contract and a gold loan business that has announced 30 percent ROE in its latest quarterly result and is touted by the bulls to be the next billion-dollar opportunity. No one on our team is allowed to utter the famous last words of many investors: “This time, it’s different.” If we never discuss a business, how will we ever buy it? No sweets in the fridge: no snacking possible.”
-Prasad, P. (2023). What I learned about investing from Darwin. HarperCollins Publishers.
Great article. Any thoughts on spotting these moat and mindsets earlier? Thanks.
Wonderful article!