Tuesday, December 27, 2005

Circle of competence and how to build the circle

Everybody has got a different circle of competence. The important thing is not how big the circle is, the important thing is not the size of the circle; the important thing is staying inside the circle. And if that circle only has 30 companies in it out of 1000s on the big board, as long as you know which 30 they are, you will be OK. And you should know those businesses well enough so you don't need to read lots of work. Now I did a lot of work in the earlier years just getting familiar with businesses and the way I would do that is use what Phil Fisher would call, the "Scuttlebutt Approach." I would go out and talk to customers, suppliers, and maybe ex-employees in some cases. Everybody. Everytime I was interested in an industry, say it was coal, I would go around and see every coal company. I would ask every CEO, "If you could only buy stock in one coal company that was not your own, which one would it be and why? You piece those things together, you learn about the business after awhile.

Funny, you get very similar answers as long as you ask about competitors. If you had a silver bullet and you could put it through the head of one competitor, which competitor and why? You will find who the best guy is in the industry. So there are a lot of things you can learn about a business. I have done that in the past on the business I felt I could understand so I don't have to do that anymore. The nice thing about investing is that you don't have to learn anything new. You can do it if you want to, but if you learn Wrigley's chewing gum forty years ago, you still understand Wrigley's chewing gum. There are not a lot of great insights to get of the sort as you go along. So you do get a database in your head.


Excerpt from "Buffett Talk to MBA Students at Florida University 1998"


Actions:
  • Read the annual reports of the company you are interested in as well as its competitors'
  • If a friend of yours is working for the company you are interested in or its competitors, ask him about the industry opinions
  • Research MSN and Yahoo for information about the interesting company and its industry

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