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All right, folks, we’ll welcome to Investing for Beginners podcast episode 162 tonight, Andrew and I are going to go back to the well, and we’re going to talk about the circle of competence. Again, this is going to be part two. So we had some other thoughts that we wanted to expound upon. After last week’s episode, we enjoyed making that conversation, and we had some other ideas that we wanted to talk a little bit about. A circle of competence is a very important subject. It’s a very important topic, and I think it needs to be explored as much as we possibly can. So without any other conversation for me, I’m going to turn it over to my friend, Andrew, and we’re going to go ahead and get started.
I completely agree with that. I think it is a topic that does need extensive coverage and particularly because there’s more to it than we talked about. So I got this idea from three different sources. One was a podcast with Jeremy grants. You’re familiar with him, right, Dave? Yes. Maybe you can intro why we should listen to him.
Well, he is a partner for a firm called GMO if I remember correctly, and he is a value investor, very, very smart guy, but his specialty is fixed income, particularly bonds. That’s where I’m familiar with him. And that’s frankly, all I know, I just know he has like a ton of money and has had a good track record. And he’s, he’s one of those like value investing legends. I then know about the bonds part, but I also know, I think he either, he was like how the really popular book is academic, really popular academics. So they, I can’t remember. But anyway, so he, he brings up this idea or this, this kind of finding that he, he came across.
And so he was talking about how there’s a lot of opportunity for people. And I believe he was talking about investors too, but there’s a lot of opportunity in the holes that people are filling. So, you know, you have a world where everything is getting so specialized, that it’s the overlap of that specialization that can make huge opportunities and leads to a lot of great discoveries ideas. So he gave an example where he said that you know, climate change is a thing that’s been on people’s minds a lot lately, and it’s something that scientists are trying to fix. And so, on the one hand, you have the climate change scientists. On the other hand, you have agricultural soil scientists. And he said he was shocked to find out that not only did they not interface with each other, like in my mind, but that also makes sense too.
It’s like, I’m sure some things go into the ground that we could study. And that has to do with climate change. He found that they were, they didn’t talk to each other, and they didn’t know the basics of the other. Person’s I don’t know what to call it, practice expertise. So the agricultural science soil scientists didn’t know much about the principles of climate change and vice versa. So he just, you know, that’s something that stuck out to me, particularly because I was also watching a documentary and this one on Netflix. I recommend if you’re a nerd like me that go check it out. I think it’s called inside Bill’s brain. It’s a documentary about bill Gates and among a lot of cool things that they talk about. They talk about his story, how he came up to talk about his relationship with his wife, talk about his relationship with his business partners and coworkers.
And, you know, later on, obviously he leaves Microsoft, and he goes on to his philanthropic adventures. And so he has the bill, bill and Melinda Gates Foundation. And so one of the things he worked on kind of in this retirement phase was eradicating all man. And now I feel really bad cause I can’t remember if it was Ebola or malaria. It was, it was one of those two diseases. I think one, one disease got figured out by scientists and another one, there were a lot of issues in this particular country specifically for whatever reason, the vaccines weren’t working. And so, you know, they, they spent so much money on this problem, and they just could not figure out for the life of them, why this illness would keep reappearing. And so what he found eventually with enough data was that there were all these circles were, where these immunizations were happening, there was on the edges of those circles, you know, where two circles would combine where the immunizations were not being done because one person in their circle assumed that the other person, the other circle was hitting that area.
And so whether that reason or another reason these, these edges were not being covered. And so that’s why the thing couldn’t be solved. And I just, I, I see a lot of similarities with that, and it just makes me think about, you know, how does that apply to us with the circle of competence? And are there a lot of opportunities for us if we can kind of hone in on a couple of specialties? And so, you know, something I, I presented to Dave, and I wanted to share with you guys was maybe some examples of archetypes of you almost think of it as like mental models. So, you know, how do we even define the circle of competence? And then if we can find places where those circles can merge, then, then find a lot of opportunities. So I guess the last thing that made me think about this, I was reading a book about oil, and they talk about one of the most successful businesses that are ever pretty much of all time.
Like if you think about monopoly, you think about like greedy American capitalism, you just have to go back to standard oil. And they were probably the biggest company in the United States and the way they, they dominated the oil industry was just absolutely fascinating. And it’s something that’s, that’s fun to learn about, but it was interesting for me to read about the history of the oil industry in America and hear that different companies within the industry all had their unique strategies. And there was one strategy that, that worked for a very, very long time that that shown out above all the rest. And that was because of John D Rockefeller. And he was just very, very good at being efficient, driving every little part of the business. Like the book talked about how he was just super, super meticulous. He, he counted things down to every last cent.
And so he was able to squeeze profits both from the revenue side and from the cost side and the way he built networks of transportation to bring oil up and down through the States, the way he, whether you want to call it ruthlessly or not would squeeze out competitors. He would get into price Wars and, you know, similar to what Amazon did; he would because he was so big and had so much money. It was so powerful. He would drop prices down to squeeze out all of the weaker competitors. And then once you have the monopoly in that market, bring the prices back up and just have huge profits. And so, you know, on one, one kind of side of that industry, you had him. And then on the other side and other parts of the world, you had other leaders of these companies who are maybe not the same personality as John D Rockefeller, but they had other unique strengths that they use to their advantage.
So another example is a person who was able to bring technological innovation and what that technological innovation did was allow them to ship oil to many distant parts. They were able to do it over the sea, and that changed the industry too. And then he combined it with his political connections to be able to use this canal that cuts the journey. And so that was their way of competing, and it worked very well too. And so you really, I think when you think about analyzing stocks and trying to figure out, you know, well, how am I going to compete with wall street? How am I going to compete with people who do this full time? I think that there’s, there are some advantages that can be made by trying to compartmentalize stocks and, and maybe separate it into a separate circle of competence is that you can a see if CFA see if you feel like you could have some expertise in it.
And then B see what the other side of the circle competence is, and then see where the overlap if there’s any overlap. So I’ll give a couple more examples, but the first I’ll say, like, if we look at some of Buffett’s best stocks that he ever purchased, I think of Coca Cola as an example. And so if we look at Coca Cola, obviously it’s a consumer brand company, you know, Coca-Cola, the most popular brand of all time, got exported out throughout the world. I’ve talked about that over and over and over again, but at the same time, one of their best competitive advantages was the fact that they control their supply chain. So well. So when Roberto Wizetta, who was the CEO, when he came in, he wanted to make sure that, that he came in and kind of cracked the whip a little bit.
And he, he pressured a lot of the week bottles out. So basically, Coca-Cola had their formula, and then they would sell it to these battlers and some sort of license agreement. Then the bottles would manufacture it, but the Coca Cola in there and then ship it out, and they would go out to customers. And so the bottle is that we’re not doing a good job or reflecting poorly on Coca-Cola’s brand. And so he, he made sure to through his, his various kind of financial moves, he made sure that to push those out, to make the other battlers step up their game. And he invested a lot of money in doing that. And he would even buy week modelers and then flip them and then sell them. And so it was more like a win-win. And so, you know, when Gazeta came in after he came in, his meetings became he, like he became popular because he made so much money for shareholders that we’re talking about, like 20, 30% a year for an extended period.
So I think that’s one example of where the circle of competence is can. Maybe we can present a couple of other examples, Dave, to give an idea of if I’m somebody who knows consumer brands pretty well. There are so many to look at, but the consumer brand like Coca Cola is going to be different than a consumer brand like Apple, where Apple’s not necessarily worried about it. I mean, they are worried about all the things that you would have to worry about with a supply chain, but they have something else that’s a bigger part. Right. And I think that would, that would line the Coca-Cola consumer brand to be different than an Apple consumer brand.
Yeah, for sure. And I, I love the idea of the different archetypes that we were talking about before we came on the air. I think that’s a brilliant idea. And I’m excited to share this with people, the idea of kind of how this works, and the Apple example is a perfect illustration because you can argue that Apple is certainly a consumer brand. After all, it’s a customer-facing business. They have stores they deal with the public, but when they’re selling their iPhones, their watches, their Mac books, whatever device it is that they’re selling or service that they’re selling, it’s certainly customer-facing in that respect. But there is most certainly a tech company as well because they have to produce all those things. They have to think of those ideas and be creative and come up with the idea for something like an iPhone or a Mac book or an iWatch, and anything else that they may try to do in the future.
So it certainly falls into both of those categories. And I think that’s a great idea., another idea along those same lines is Uber. Uber is certainly a customer-facing company because they deal with all the people that work for them those drive cars. And then, of course, the customers that they pick up and take to their destinations are certainly customer-facing. But then they’re also falling back into the tech world because of the app and the technology. That’s evolved to allow the people that drive for them to find customers, to pay them, to pay Uber, and to pay the people that are driving the car. So it goes both ways. So it certainly falls into both categories, I think,
I think. Yeah. And I think it sounds like common sense when we lay it out. But if you think about the implications of it, if you’re studying businesses that did well, like go back to the John D Rockefeller example, if you try to run Apple, like you ran, like he ran standard oil, it’s just not going to work. You know, it’s, it’s, it’s not the same skill set. It’s not the same business strategy. They’re two completely different things.
And I think along The same lines of what we’re talking about with Buffet, going back to his portfolio Geico is another perfect example of a company that it’s an insurance company. That’s what they do, but it’s also a customer-facing, and it’s a consumer brand because everybody knows who Geico is. You have the little green gecko running around marketing the company, and everybody knows what Geico is, but it’s also dealing with, with customers selling its product to people. And it also falls into the financials because it’s an insurance company and all the things that go into valuing an insurance company and dealing with investments and money and premiums and all the different aspects of that. So, it, it encompasses two different kinds of archetypes if you will. And I think that’s
A great example. Hey, you, what’s the best way to get started in the market—download Andrew’s free firstname.lastname@example.org. You won’t regret it.
Yeah, well I guess, well, there are a couple of others I can think of like July as another example from Buffet’s portfolio where tech doesn’t change razors, so we’re not going to apply, you know, you’re not going to spend much in on R and D as an example, if you’re a tech-focused investor, maybe you’re looking a lot at R and D or, you know, what’s the reputation, how are they drawing talent and those types of things versus like Gillette, more like Coca-Cola where there are commodity aspects to it. There might be a razor; maybe it isn’t necessarily better than another. Even if you could claim it has all the best tech in the world. People don’t care. It’s not changing some of these lives, but that brand is really important. And so if I were looking at a company like Gillette, I would be looking to see how are they dealing with distribution?
And the commodity aspect of that business, like Coca-Cola, would be like an oil company would be, but also how are they managing their brand? And again, that’s a lot different from Apple has a brand, but they also need to spend a lot because their products need to be fast enough. You know, they get that the phones have to have the right camera and they have to have the right memory and the right speed. And so that, that’s, that’s kind of, as I look through the different types, I’m starting to see a lot of businesses look similar and maybe they have a main focus and then like a side focus. So I think that there’s like commodity would be one because that’s, that could be a beast on its own because you can have commodities that maybe fluctuate with up and down in price and then a commodity type that maybe just stays more static.
But I think in general, you would look at it as a commodity business, and then you have consumer brands, and then you have the tech, and then you have finance. And those are the four big ones that popped into my head. And I feel like you can categorize most, any stock as a combination of two, where I think sometimes the trap is we’re categorizing them as just one, or maybe we do not even think though that what we think that each stock has its own unique thing. Still, it’s really that they’re following similar strategies and similar paths that you’ve seen before. They’re just called different things. Exactly. And I think the thing that I like about looking at companies like this is, it also helps you, if you have a strength in a commodity, for example, or you have a strength in consumer brands. It’s a little easier for you to expand, to include something like tech into that, I guess, archetype or that circle of competence.
Because of it, I was thinking about that. We were talking about this earlier this week about Intel. And as I’m looking at the company, I realized I don’t have to know every little in and out of how the tech works. I just need to understand it enough to understand what the demand for it will be not only now but in the future. And so that I can try to determine whether that’s something that would be of benefit to the people that they sell it to. But then also to me as an investor, because that’s going to make the company more relevant for a longer period, which is something I want when I invest in a company. So I think looking at these as we get closer to the edges like you were talking about with the viruses in bill Gates, I think those are a great example because as you get closer to the edges, then things start to get a little bit fuzzier, but then if you can narrow down what it is you’re trying to learn.
I think you can; I think you can overcome some of that fuzziness at that point to be more comfortable about certain aspects of that. If thinking about other companies that kind of go along with something like this, I think of a, I may go back to Intel. I think not only are they a tech company, but they’re also a commodity company, and they obviously have the tech where they’re building stuff and being creative and trying to come up with all these great ideas to make the technology better. But they’re also in much more important, not more important, but it’s equally important is the distribution and having the channels to be able to sell those products across the world.
And if you don’t have that chain, then you’re just kind of barking up the wrong tree. Yeah. And you know, I think what, when you talk about Intel, in particular, I think what kind of contributes to looking at them as a commodity is what they’re selling is based more on supply and demand than anything else. In the sense of, I’m using the same examples over and over again, but it’s, I think it’s easy with Apple Apple, really their demand is set by how popular it is and how much people want it. Whereas somebody like Intel, who’s going to be selling their chips to other consumer-facing brands. They’re more worried about, you know, is our chip because the chip can be performed well. But also if it’s not cheap enough that the customers will just go with the competitor, right?
So they’re kind of subject to those prices and the price aspect of a commodity. And also they have to deal with the fact that our company is not going to be very loyal to their suppliers. And if you’re not getting the job done, if, if the performance isn’t there or if the price is getting too expensive. And so that’s harder to overcome than a consumer-facing brand where they’re going to get a lot more wiggle room. And so that’s why you do have to look at that aspect of it in addition to the tech side too. And so kind of going with Glenn going along with that, I liked what something you texted me last week. Dave, you mentioned cause you know, we were kind of talking a little more about what we talked about last week, about the difference between the FB GA’s and the Asics.
And so, you know, if, if that’s a little lost on you as the listener, you can go back and listen to last week’s episode, we kind of entered that. And so, you know, I was talking about how it kind of made me doubt the company a little bit. I didn’t know how the whole Altera acquisition was going to work out for them based on the fact that you can’t know much about how the tech that Altera is focused on will fare in the future, brought up was, well, can’t the costs or can’t the size and scale of Intel, bring a tailwind to that and make it easier for them, you know, not to make it a guarantee or anything. Still, those additional resources can help what Altera brings to Intel. And that’s something where I think that kind of goes back to maybe how, how traditional business in the commodity standpoint can work. And if you mix that with tech, then now you’re, you’re talking about using financial, the great financial resources that Intel has to make some technological innovation that wouldn’t have been possible if Altera was just by itself. And that can change the feature too. And
I think that is something, you know, we talked about a lot of the bear sides of Intel last week. I think that’s something that could be a bullish thing for Intel, particularly if the price is right too, to, to have that kind of upside it’s, I think it’s something to consider. It is something to consider. And that was one of them, the more bullish things I was thinking about what the company and that’s kind of why I said it to you last week. And I think that that is one of them, I guess, the advantages that the company has. And to further solidify that for me today, I was reading through AMD’s 10 K, and that was one of the things that they mentioned over and over and over again in their 10 K was the impact that Intel has on the semiconductor industry because of their size, because of their, their market cap. Because of the money that they have, they have the resources and the financial money to go out and buy more of these companies and impact what’s going on in the industry a little bit more than AMD does because AMD doesn’t have the same financial wherewithal to do some of those things.
And that to me gives me an idea that maybe Intel, even though I know, they’ve been getting bashed because they haven’t quote-unquote, what have they done for me lately kind of thing. And what little I know about tech, it seems like that it’s a little more about when things are not happening as quickly as everybody wants them to then sometimes people are a little like, eh, why, what have you done for me lately? But I also go back to the idea of Microsoft Microsoft years ago before they were the tech giant, that we all know today, they were an acquirer of companies that would help them expand upon the different products that they had. For example, the internet before internet Explorer became the big thing back in the day; they weren’t getting where they wanted to go. So they went out and bought a company called Netscape that helped them become the internet Explorer that kind of killed AOL.
And so that was a great acquisition that Microsoft did that allowed them to take the next step in the internet world. Another one was, I don’t remember the name of the company, but they were struggling with Microsoft Excel. And so they bought a company that was working on a program that was very similar to it. And that’s what morphed into Microsoft Excel, which Andrew and I are both huge fans of. And Andrew’s way better at that than I am, but you can’t be in a finance geek without Excel. And so I think that Intel, I think that that is something that I can’t predict that because again, I don’t know enough about the specific tech part of it. Still, I just think that they’re in a better spot financially because of their size of the company, where if they’re getting stuck in and, and struggling to create this specific product, I don’t see any reason why they can’t go out and try to acquire a company to try to help them do that.
And there’s nothing wrong with that. And, and there are a bazillion different companies out there that have done that and will continue to do that. But we’ve, Amazon has probably done that along the way as well. So it doesn’t always have to come from within the company. And so I think to me, that’s something that I’m excited about, and I know that I’ll Tara was a company that they bought, and they’re still working on getting everything I guess, assimilated if you will. And I think that that will we do great things for Intel shortly and down the road,
I think it must possibly. And I think it’s the perfect example of everything we’re talking about today because you can get it. It can be very easy to be so lost in the tech part of tech when you do not realize that something like this is possible. And so what you’re talking about with what Microsoft did would be a perfect example, too, you know, so to say, if these companies that they acquired were really small businesses and whether if they were publicly traded, I’m sure the tech people would be enthused about these small companies and say, Microsoft is washed up and isn’t cutting edge—not considering the other possibility that their size and scale and acquisition strategy if they do it correctly, can help them overcome the whole old dinosaur effect. But you won’t know one or the other unless you know enough about both.
And so I think in Intel’s case, it depends on if there if it’s likely that they’re making good acquisitions and if they have a prudent acquisition strategy. And so for somebody who’s trying to pursue that, maybe they look at other companies who have been successful with acquisitions and see if M if Intel’s following a similar path and then you can take that third circle of competence, which God forbid I haven’t called a circle of competence. Still, you know, an understanding of the numbers and the financials, and try to figure out what they paid for these acquisitions. And if they’re in the ballpark of making sense, and I think the decision making can become a lot better. And that’s where a lot of the good returns from value investing can come. If you can understand those things and maybe think outside of the box, stretch those circles and find, find the overlaps and then find opportunities in those overlaps.
I agree. And I think that’s what I like about talking about this. And that’s what helps me having you as a resource to talk about the tech part of it. Because honestly, when I first read through Intel’s 10 K, and I saw all those acronyms for things like ASIC and FPGA and CPUs and APUS and all that kind of stuff, I was like, what in the world is this? And, but after our conversation last week, it all started to make a lot more sense. And so when I went back and looked through it again, I was like, Oh, okay, I get it now. And I may not know, again, all the tech specifics of each particular chip, but at least understand what they’re designed for and what their best function is for and possible, I guess, outcomes that they could have from selling these different chips to different companies.
And just a better overall idea of how the company goes. I would not consider myself a tech expert by any stretch, but I always feel like I have a much better grasp on some of that aspect of the business. And then when I take that and look at the numbers, things start to make even more sense. And that helps me realize that, Hey, okay, maybe this is an opportunity waiting to happen. And one of the other things that I liked about Intel was that they have other irons in the fire. So they’re not just sitting on semiconductor chips as their complete total bread and butter. They have other irons in the fire that they’re stoking that could weed them to even greater revenues shortly. And so those are things that, for me, make me a little more excited about the company.
And again, it’s because I have a better idea of the, of the business of Intel, as opposed to just the numbers of Intel. And that’s what helps, you know, when you’re trying to value or analyze any of these companies, once you have a better idea of the overall picture of the company, then it starts to make it not easier. Still, it does make it a little more, less stressful, I guess like, Oh, I guess I can kind of start to get this a little bit. Yeah. And I think that’s going to show too when it comes time to sell either if you’re thinking of selling it or you’re nervous because the stock goes down. You don’t know whether you should sell, that sort of the circle of competence is going to come in, because if you understand what’s going on, then you’re more likely to make a decent decision versus freaking out and then feeling like you don’t know anything about it.
Yeah, absolutely. That’s that? I agree with that a hundred percent. And, and for me, that’s how I felt when a lot of the banks were getting spanked back in March and April because I understood the businesses and understood how a lot of them work and realize that a good majority of that was just overall negativity of the market. But the underlying fundamentals of some of those companies were still cooking along, and they would start to bounce back, and some of them have, so it’s going to take longer, but it just, it does give you a lot more confidence to understand what’s going on.
Well, because you understood how much they have in reserves and how that would affect, you know, how that cushions them against defaults and everything. Right? Yeah. Yup. Exactly. Yup. Exactly. There you go, Michelle.
So we answer one question before we sign out here.
Yeah. Why don’t we, okay. All right.
So I’ll go ahead and read this here. All right. So we have, Hey Andrew, I’ve been listening to your podcast and started investing in April and became a subscriber of your research. E-Letter in June for this month’s stock pick. I decided to wait until my second pay period to invest in the recommended stock pick. The stock has price has gone up to 144 31. Is it too expensive now to invest in it? Or should I wait until I go down again? If it does, to be honest, I didn’t expect it to go up that amount in a short period. I thought if I waited until my second pay period, I could get it around the 129 53 stock price. It seems like the best way to approach this next time is to invest in a stock pick. As soon as you recommend it, I would value your input. Thanks. I appreciate your guidance, Michael, Andrew, what are your thoughts?
This is kind of a touchy subject for me, and it’s the reason why I picked it because of it kind of grinds my gears a bit. I guess I get a lot of requests. I wouldn’t say a lot, but I’ve gotten requests where it seems like people want to build a portfolio from scratch. And I, you know, I get that, like you’re coming in new and everything. I just, I get these, these questions where people say, you know, I have
This much to invest, and, you know, I want to build a portfolio. What are the 10, 15, 20 stocks I should spread it out into over and over and over again. It’s just; it just doesn’t work That way. Right. It’s you don’t have 15 to 20 great ideas in a given month. And so something I’m reigning in on with the e-letter is making sure that the stocks that I recommend still buy. And so a stock like this one that Michael talks about, you know, when I recommended it, I saw it at a good price, and now it’s, it’s much higher than that. And so if it were me personally, I probably wouldn’t buy at this price. Last I checked, it was up to something like 20% in a couple of weeks. And so is it a good company? Yeah. Is it a good stock probably, but has the business grown 20% in the past few weeks? I think it’s hard to say yes; they’re there. Of course, there’s always is the possibility that it’s still cheap, even though it’s gone up 20%. And so that’s something that I’m thinking of as, as, as I, as I release each issue, I’m looking at every stock I have and trying to determine, you know, is it still cheap enough?
And you’ll never have the perfect answer, but I think the obvious answer is yes, please do try to buy the stock when I recommend it. But, you know, on the broader scale of the big picture question, you know, should I buy a stock? That’s, let’s say 10%, 15%, 20% higher than where Andrew recommended it. Is this something I should buy now? And, you know, I just it’s a case by case basis, but a lot of times, if it has gone up a lot in the short amount of time, there’s a good chance that the business hasn’t grown that much. So a lot of the times I’m probably going to stay out of it. And so I’m trying to be as clear as I can and the leather issues. And then maybe that’s something I need to work on in the feature of really just being selective and just saying, you know, these are the stocks that haven’t gone up in price since I recommended it.
So these are still good buys, but a lot of the other ones, even though they’re great companies, might not be good buys at these prices. And so if you’re wanting to microwave your portfolio right, and have a fully diversified portfolio by tomorrow, there’s nothing we can do about it. And so maybe that’s the approach moving forward, but I think, I think there’s a difference between a good stock, a good company, and a good company with a good stock at a good price.
All right, folks. Well, that is going to wrap up our conversation for this evening. I hope you enjoyed our conversation about the circle of competence. It’s a very important subject, and it’s something that needs to be considered very strongly when you’re working on what kinds of companies you want to buy and what kinds of areas you want to branch out. So without any further ado, I’m going to go ahead and sign this off. You guys go out there and invest with a margin of safety emphasis on the safety, have a great week, and we’ll talk to you all next week. We hope
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