The circle of competence is so important to investment, how can retail investors establish their own circle of competence?
Ability circle is the culmination of the value investment school Buffett The concept developed by predecessors in the investment wisdom of their predecessors. Investment success does not depend on how much you know, but on how much you don’t know. "Invest in your own circle of competence," Buffett suggested, "This is not a question of how big the circle is, but a question of how you define the circle." So how should investors establish their own circle of competence?
1. The core of the circle of capabilities is certainty
Buffett said, "In the long run, the market will experience extraordinary or even extremely strange situations. As long as you make a big mistake, no matter how many successful records there are in the past, they will be wiped out." It can be seen that the importance of certainty is for investment. If the return of investment is 1, then the uncertainty is 0. No matter how high the return is, if there is no certainty, the traversality of probability will definitely return to zero. How do
understand this certainty? Looking at Buffett's investment history, he has successively drawn many boundaries for himself, such as business boundaries, safety margins, capability boundaries, management boundaries, etc. The purpose is only one, to resolve risks in investment and find low-risk and high-return investment opportunities. Only strong certainty can bring the time effect of compound interest. This is the essence of investment, not the yield of a single investment.
In his letter to shareholders, Buffett said: "Although such risk measurement cannot be as accurate as a project, it can at least be sufficient to make effective judgments. When making an evaluation, the main factors are the following: (1) The degree of certainty of the company's long-term business characteristics can be measured. (2) The degree of certainty of the company's management class being able to leverage the company's potential and effectively use cash. (3) The degree of certainty of the company's management class returning the benefits obtained by the company to shareholders rather than to enrich the private pockets..."
shows that the essence of the circle of capabilities is certainty. So how do you do it around this core?
2. The key to the circle of ability is boundary
. Buffett and Munger have discussed the issue of the circle of ability many times. Success in investment does not depend on how much you know, but on how much you don’t know. "Invest in your own circle of competence," Buffett suggested, "This is not a question of how big the circle is, but a question of how you define the circle." Then let's understand the wisdom of Charlie Munger : If you want to understand how to be happy in life, Charlie will first study how life can become painful; to study how companies can become stronger and bigger, Charlie will first study how companies decline; most people are more concerned about how to succeed in stock market investment, but Charlie is most concerned about why most people fail in stock market investment. His way of thinking comes from the philosophy contained in the following farmer's proverb: I just want to know where I will die in the future, so that I will never go there to . It can be seen that both wise men are emphasizing the issue of boundaries. There are two ways to determine the boundary of
. One is the strong thinking represented by Buffett, who clearly knows what you know, and then moves within your territory, and the other is the weak thinking represented by Munger. You can also find your territory by finding what you don’t know. When investors grasp the boundaries, they will be much richer than those who are larger in circles but not very clear about the boundaries of the circle.
Now we know how to find the boundary, but how to determine the center of the circle? I think it can be explained by Buffett's "four-leg theory", that is, when we look at a company, we can analyze it from four perspectives:
first, the business of the company is something we can understand. Whether you can understand it is related to everyone's knowledge reserves and experience background. Some companies can understand some people, but not others. Moreover, this understanding refers to understanding investment, mainly the development prospects of the industry in which the company is located and the company's competitiveness analysis.
The second one, the company has good economic prospects.The good economic prospects of an enterprise are our judgment of the business environment in which the enterprise is located, the continuous analysis of the competitiveness of the enterprise, and our comprehensive evaluation of the efficiency of the enterprise creating value for shareholders. We can analyze whether the enterprise's past operations are stable and whether the financial performance of the enterprise's operating results is good to assist us in our judgment.
, the enterprise has a manager with both moral integrity and ability. If a boat wants to run fast, it is a manifestation of the nature of the boat and it is also the result of the captain's ability. Good investors are both morally and capable, have strong professional business management skills, attach great importance to the interests of shareholders, and personal character, such as enthusiasm, honesty, etc. are part of it.
The fourth, stock has attractive prices. There is no need to talk about this. It is worth noting that in Buffett's later investment, the importance of corporate quality is increasingly emphasized, and the price position is not that high-quality company. He believes that it is better to buy a high-quality company at a suitable price than to buy an ordinary company at a cheap price.
By asking and answering these four questions, investors can find the center of the circle of ability.
3. Misunderstandings about the circle of competence in practice
Although the concept of the circle of competence is simple, there are many misunderstandings in practice that need to be paid attention to by investors.
First, the boundaries of the circle of ability are greedy. Although from a long-term perspective, investors can only make money in their circle of ability, and outside the circle of ability is destined to be a game with negative numbers. Many people know their boundaries of ability, but when they see others making money, they can't help but want to try it out. They lack the quality of patience, are impatient, suffer losses outside, and lose the meat of the circle.
The second one is to treat the results of the investment as a proof of their own circle of competence. Some investors read other people's analysis or randomly operate a stock, and make a profit after catching up with the market, they will think that this is their circle of competence, but they don't know that they are the turkey staying there. When the tide recedes, you are the only one swimming naked on the beach.
The third one is to mistake industry information as a circle of capabilities. Some investors have read some research reports, or are industry insiders, or have conducted limited research, treating the data and information they have mastered as certifications in their circle of capabilities, and have not straightened out the development prospects of the industry and the business direction of the company.
is the fourth, and it believes that the circle of ability is unchanging. This is typical mechanicalism. I did not realize that my original understanding was not comprehensive, I did not find that the actual operation of the company had changed, and I still deceived myself in my past achievements.
If a company can make money depends on its competitiveness, then whether investors can make money depends on their circle of competence. If a company can make money in the long term depends on its moat, then whether investors can make money in the long term depends on their strength. An investor is an enterprise, and we are responsible for our own profits and losses. When we invest, we must not only analyze the operation of the enterprise, but also pay attention to building our own circle of capabilities.
