Back to the Basics: Circle of Competence

0:00Circle of competence sounds fancy, but it's not really that fancy. Here's what it is. It's know what you know, but more importantly, know what you do not know. A lot of investing mistakes don't just come from bad math. They come from the fact that you're investing in a business. You have confidence in a business that you really don't know at all. You don't have a good understanding of what that business is and how they make money. So today, Andrew and I are going to dive deep into what the circle of competence means, what it is, and how you can find out where your circle of confidence is and most importantly where it is not this show is sponsored by liquid iv now that the weather is finally heating up one of my favorite ways to step away from spreadsheets and the sec filings is getting outside for early morning run but once the summer heat truly kicks in and i start breaking a serious sweat i know i need to hydrate and actually replenish and it gets a lot more important no matter what activities get you moving you need to stay hydrated as well Liquid IV delivers longer lasting hydration than water alone.

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3:17Stephen:discipline and the conviction to buy wonderful businesses and stick with them. Your path to financial freedom. Welcome back to the investing for beginners podcast. Everybody. My name is Steven Morris and across from me is Andrew Sather and Andrew today. It's really funny to talk about this because I remember the first time I heard it, I thought I knew what circle of competence meant. and so i was like talking to everybody like i knew what it meant and then you guys corrected me i don't know if you remember it but i remember like it was last summer ish maybe and like once you guys explained it to me i was like oh yeah okay that makes sense but the funny thing was like that's not what like i thought so competent like what what does competence mean you know So I didn't put two and two together on what you guys were talking about.

4:16So this is going to be, it's a funny conversation to me because I remember that vividly getting corrected. Oh, it was when I was making the circle of, or I wasn't making it yet, but we were getting ready to start the Circle of Competence Challenge within the Value Spotlight community. and um i don't remember whose idea it was but it's like oh yeah and i started throwing out ideas and then you guys had to like correct me on what a circle of competence actually means

4:53Stephen:so the still don't remember it no i i remember the challenge but do we and i don't even think we ended up actually doing the challenge it was just an idea to no we did we did uh sea ocean one he kicked all our butts that's right yeah um and that that was really unfair but it is what it is um so shout out to sea ocean but uh but yeah so just go ahead in your own definition what what does circle of competence mean yeah i guess in the lens of stock picking it would be where you have understanding of a business and And also, in my mind, it's kind of wrapped around where your advantages are as an investor.

5:42Stephen:So I think the classic example is like technology. If you don't know how to turn an iPhone on, maybe technology is not in your circle of competence. So defining where a circle of competence is helps you as an investor because then you're not having to learn the hard way with every investment you make. Yeah, definitely, Andrew. And I think one of the keys to the, not just, like I said in the very beginning, for me, at least one of the keys is understanding what I don't know, because it's real easy for me to look at a company like Eli Lilly. I know a lot about Eli Lilly because my neighbor works at Eli Lilly.

6:28I know a lot of the management from Eli Lilly because it's literally right down the street from me. um i grew up with eli lily so it's easy for me to look at eli lily and think i understand it but in the grand scheme of things pharma is not something i understand at all and i couldn't begin to tell you the ins and outs of how they actually make their money uh how important patents are if that or is it a patent i don't even know see i don't even know do do they get patents for their drugs i have no clue how all that works so from the you know from the 30 000 of you i look at at a company like that and it's like yeah i know about that but in reality i really don't

7:16Stephen:i i'm having this like picture in my head of you could throw a play out there on the football field and think you know how football works but until you get a counter from the defense and then you have to adjust to that. You don't really know how the game works. And I think with investing in business, I love the way you bring up like, you know, different pieces of it. But if you don't know the entire picture, when it comes to businesses, not only should you know how they make money, but ideally you would know, okay, what are the things that are going to lead to this business doing better than that business or this business making more money than that business?

7:54Stephen:And it's not just where are things now, but what factors play into why does somebody pick Texas Roadhouse for a steakhouse versus Longhorn Steakhouse or whatever the comparison is. Understanding the moat and the competitive damage means you understand how other factors come into play and really hopefully see the future a little clearer if you can. yeah absolutely and i want to pull it to thread no that's not what you and evan say what's your and evan's thing that needs to be a t-shirt too because it's so goofy um double click um i want to i want to double click on one thing there and that is you know you you say you need to understand how can you tell me what does that actually mean do you do i need to be a expert in texas roadhouse like do i need to be able to from the top of my head you know throughout their their uh competitive competitive advantages um do i need to be able to throw out numbers like how much understanding do i need to have i think it's both so peter lynch always says invest in what you know so it'd be really hard to invest in texas roadhouse if you've never eaten there If you've never liked steak or understand why people make the decisions on where to eat that they do.

9:31Stephen:So part of it is kind of having the eyes of the consumer. And then the other part of it is the business part, the ways that they are different, the ways that they operate and the line items that are important to them, like labor, food costs, things like that. and how management is making their business different, all of those things play into painting that picture of, is this company really a great company? If stock picking was as easy as just, let me just find the 10 fastest growing businesses and buy all 10 of them, we wouldn't be here talking on the podcast and having people paying attention.

10:14Stephen:It's harder than that. And it's because of the fact that what happened in the past doesn't mean that you're going to have great success in the future. Yes, businesses do do that, but they usually have something else that they're bringing to the table that allows them to continue to dominate over years and years and years. And those are the things we want to look for when finding great businesses. Right. And one of the areas I really struggle in, you know i i use deli lily as an example but you've mentioned like i like i'm a kind of a shoe guy so i'm a big consumer of shoes uh but just because i know the product nike makes doesn't mean necessarily i understand nike's business um you know we we we talk or i've talked before about the uh you know kroger or ingles depending on what part of the world you live in grocery store chains that yes they're grocery store chains but their actual revenue drivers are the real estate they own kind of that mcdonald's model that we've talked about um just because you you know just because you understand the the kroger is a grocery store doesn't mean you understand actually how the business makes money or what even the risks are.

11:43And I think that's one of the, for me, that's one of the most important things, I think, for me, is being able to identify their moat and then identify kind of the chinks in their armor that causes them exposure to the market where they can get taken advantage of or lose ground.

12:09Stephen:Do you remember the first stock where you felt like you had a decent circle of competence on? Yes, Zotus. Okay. Yeah, yeah, yeah. So how did you come to the moat and understanding some of the risks? because that's not like a consumer-facing name, so it must have been a little more work than looking at Starbucks or something. Yeah, so I was talking to one of our value spotlight people, and I don't know if he ever ended up buying it, but he was really big on the company, and he had done a ton of research. And so he was talking to me about it. And for those of you that don't know, Zotus is a pharmaceutical for farm, the farm industry.

13:11So, you know, cow vaccines, things like that. They also do a lot of work in crop retention, bug repellent type stuff. and they focus pretty heavily on green. So trying to get away from harmful chemicals, things like that. And that is a super huge challenge. And so part of the reason it really sparked interest in me is because I grew up in Indiana. I grew up on a farm. That was my very first job, 11 years old, mucking pig stalls. I understand farming. very well. And so I also understand the importance of taking care of your livestock. So it just kind of sparked interest in me and I started like diving into it.

14:02And as I got deeper into it, I kind of realized like, wow, this is what it means to have a circle of competence around everything because around something, because I understand the language they're using i understand why they're focusing on this product i understand why they're why they also have a a side of their business that is solely focused on green and organic and non-gm like that is a because that's kind of the trend the way things are going or looks like they may go so they need to be prepared for that um and so yeah i still own them um they've done really well I couldn't tell you how well they're doing for me, but they are doing well.

14:50And so, yeah, that was the very first company I bought where I truly felt comfortable. Like, I know this company well.

15:00Stephen:That's awesome. What kind of resources were you using to learn about the business? Google Foo plus something else? Well, yeah, you know, my Google Foo is strong. So Google Foo, Finviz, sec.gov, their website. And then I kind of cheated because I went to my uncles and my cousins, who are all farmers, and asked them, like, you know, because they've all heard of Zotus and they know their products. and they know what they do for them. And so I got their insights on what they thought of the company as well, which was a really beneficial avenue, I guess, because it's not just me assuming what a customer would say about them.

16:00Like I'm actually getting feedback from customers or potential customers. So that was a big help as well.

16:08Stephen:yeah that's huge you're saying you actually read a 10k or at least you opened it we won't put you on the spot maybe you at least opened a 10k bro I read 10ks I just don't enjoy reading 10ks cool cool wow that's awesome I mean I read cats 10k you know I've read a few if you love to diversify with ETFs but are overwhelmed with all the options the Plink app can help Whether you're looking for stronger growth potential, stability, or ways to help hedge against inflation, the Plink app makes it easy to browse nearly 2 ,000 ETFs with thematic categories built around your goals and comfort with risk.

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17:18Stephen:Diversification does not guarantee profit or protect against loss. ETFs are subject to market fluctuation and additional expenses. Opinions expressed on this podcast are not necessarily those of Digital Brokerage Services, LLC, member FINRA, SIPC. I'm sure you've seen the buzz online, but let me give you a little bit more information. Live shopping on WhatNot is absolutely popping off at this moment. I've seen the shows firsthand. I've seen WhatNot climb to the top of the app store. And I've looked at the money that people can earn as selling on this platform. And we're talking small, you know, mob and pop businesses, medium-sized businesses, and even multi-million dollar businesses.

17:50Stephen:All of them are seeing massive real growth on this platform. If you're somebody who is selling or has sold in the past and you've sold online or in a storefront, maybe you're used to a full-time job or maybe it was just a side hustle for you, you already know the challenge. You're just hoping that somebody is going to stumble across your listing and you're waiting for that to be the right person to just stumble upon whatever it is you're selling. Whatnot flips that. On Whatnot, you can go live and sell directly to your buyers in real time. They see what you've got. They get to ask the seller the real questions and then they buy and they keep coming back because you've now built that genuine relationship with them.

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18:55Stephen:People selling on WhatNot are able to sell 10 times more than on any other major marketplace, and this is because they're not just listing a product blindly and hoping that the person is going to trust them and believe in them. They're building real genuine connections with the buyers and they're able to build a lasting relationship that makes that buyer want to come back again and again. And for a limited time, WhatNot will match your first$150 sold in the first month. Visit whatnot.com slash sell to start selling. That's W-H-A-T-N-O-T dot com slash sell. Whatnot.com slash sell. Right now, there are just two stocks in the United States with over$5 billion in profit that have grown revenue at 35 % a year over the last five years.

19:39Stephen:The first stock is NVIDIA, and the second stock is the company that I just made a large position for my portfolio, available only for subscribers to value spotlight. I reveal that stock pick in a deep dive research report in a generational moment, reigniting human connections through a tangible network of intangible assets, which you can access at einvest scene for beginners.com slash reignite but yeah i think that's that's uh you know and and and doing all that research one being able to understand where they where the biggest risk is and as far for as far as i can tell their biggest their definite biggest exposure i think would be the green side of the market because i think their competitors are ahead of them on that side.

20:27And that's another thing I did, I guess. I don't remember if I mentioned or not. I also went to their competitors' websites and researched their competitors as well to see what they were doing. And I think that would, hands down, would be their biggest exposure is just being behind the eight ball when the market suddenly just, okay now everything is going to to the uh i don't remember the word they use now but um the the non-heartful chemical pesticides and things like that fertilizers and so um definitely uh it was interesting an interesting feeling but it was a a lot of fun to kind of come to that realization of my own, like knowing what circle of competence was, but then like I literally felt it once it finally clicked in my brain.

21:27I don't know if that makes sense, but it was almost like a physical feeling of like, oh, like this. Yeah, okay.

21:35Stephen:Like the pieces all came together. Yeah, that's awesome. And I think another big risk, at least, and I don't speak for all of, You listeners, I don't speak for Andrew or Evan, a big risk for me that is very dangerous that I have to be careful of when it comes to my circle of competences. Is the company cool? Okay. Because I sent you a company. I don't remember the name of the company, but its ticker is like beta beta. Oh, yeah. And it said electric commercial electric airplane company. and it is so freaking cool yeah and like i was like oh man i got i gotta i gotta invest this company's way too cool to not but then as i started like actually researching it it's there there's so much risk to that it's like no but i definitely got swept up into this is a cool company not a good business they're not as i won't say they're not a good business but cool company versus good business so it's good you're like getting that sense right like you're you're tingly and spider sense yeah your spidey senses are tingling and telling you hey this might not be great for your investment dollars was it was there ever a company that you did invest in that you that what was that you you bought it because you thought it was super cool and you didn't realize it um i think my version of that is companies that have had really great stock performances and then have seen them crash so i've talked several times about starbucks but that's always been one of these that i've always told myself whenever the stock gets cheap enough i'm going to be all over it because i had that that kind of um reputation in Wall Street of like being like one of the great consumer stocks that everybody should own and so when they did um I made a mistake and it wasn't a great choice so that might be an example um but I the thing I want to bring up is like you I'm not saying beta technologies is like a bad business by any stretch or a bad investment that you just, I think putting up those boundaries of saying, I don't know a lot about whether this company will do well or not is a very, we have to think of it, not just in this particular company, but also like 10 years from now.

24:26Stephen:They say one of the best things that can happen to you if you start gambling or play blackjack or play poker is actually for you to lose because if you win you start to think that you're especially good at this game and that can be a terrible thing so like i imagine somebody who invested in tesla in the early early days thought might think now that they're like an ev expert when the the fact of the matter is like tesla was less than 24 hours away from bankruptcy. And so your investment in Tesla could have been just a 50-50 coin flip, depending on how the 24-hour period went of how they got extra financing at the 11th hour.

25:12Stephen:So putting up that boundary of saying, I'm just going to not go into this place that's not my circle of competence might help you not just in whatever stock you're looking at, but also whatever you do in the future. Because now if I'm a Tesla shareholder and let's say I'm up 100x or whatever, what do you do now? Like, what do you do with that money? Well, if you're a EV expert, all of a sudden, are you plowing that into the next opportunity? And if you actually don't have a circle of competence and you just got lucky, what's going to happen to that money? So I think being honest about your circle of competence can do a lot for you, not just in whatever investment you're looking at now, but also whatever you do with the investments that you make down the line.

25:56No, that's actually brilliant. Whenever I decided to take the leap and become an entrepreneur, I hired a coach to help me through it. And one of the things he told me is I was complaining about, you know, the entrepreneurial struggle. and I was like two months in and I was complaining about like, oh, I'm not making money yet. And he was like, good. I was like, excuse me. And he was like, bro, I'm telling you, I've seen it a million times. If you have success early, you're going to fail hard a few years later because you get cocky and you think that you're invincible because your first idea worked great.

26:45He's like, in some cases that does work. but in a lot of in 90 % of cases that that doesn't work out and he's like I hope you fail and then see success later right and I mean that's exactly what you're saying you know about the the poker or the blackjack because it's easy you know to win five hands in poker I'm that way 100 % like if I win the first few hands like I think I got everybody at the tables card or like I like I got everybody's I understand them I got their number that's what I was trying to say and it's like I get cocky and the more cocky I get like the worse I play and yeah so that makes total sense and that that kind of leads into I would say the the last trap for beginners uh to definitely be careful of but all of us is just the narrative like understand that you're not getting swept up into the ev narrative because ev is the hype that's what that's and is combustion going to go away maybe in the future i have no clue but what i can tell you right now is our infrastructure and numerous experts have stated this exact fact that our electric grid cannot support the entire country being ev and so you know now is that going to be the case 10 20 years from now i have no clue but that doesn't my my point is that the narrative for ev suggests that next year or in a couple of years everybody's going to be driving a tesla and a rivian

28:30Stephen:but that's not necessarily the case i might play a game with you yeah we totally shouldn't we totally shouldn't get seduced by narratives i'm 110 off for that i'll play a game with you would Did you buy an EV at gas prices at$6 a gallon? No. Eight. No. Ten. No. Twenty. No. What? A hundred. No. Okay. I saw. I do not sell my Jeep, period. I drive my Jeep until. Drive the Jeep until you go bankrupt. Yep. or i'm just gonna be in the best shape ever because i walk slash run everywhere right it'll be like every every uh half mile you drive it's just like pain um i did see something apparently four dollars a gallon is the tipping point according to economists or whoever that people in the U.S.

29:35Stephen:seriously consider switching the EV. Really? So I don't know how true that is, but. I mean, it makes sense because if you think about it, the price of a Tesla has gone way down. And a lot of EVs are getting relatively cheaper because back, you know, just, what, four years ago, it didn't make sense because it was going to take you, you know, 10 years to recoup that in gas savings. But now, I guess since COVID really, like those prices are steadily coming down as the technology gets better and more available, I guess. And yeah, like it's taking less time to recoup, if that makes sense. I mean, I remember 2020, it seemed like EV was everything in the stock market.

30:31Stephen:it feels very much flipped where you're almost a fool to buy Tesla stock today is that because Tesla is so expensive right now I I don't know I mean it just it seems like everybody's against the EV trade you look at Rivian stock they're down 87 percent from their peak and still down um they're coming out with earnings probably by the time this goes live earnings will be out already and there's they're releasing like a new model um so i i yoloed into some rivian so i think that's why i'm interested

31:17Stephen:but like just if you look at that stock chart you look at tesla you look at the wave for GM all those stocks haven't really done great it's just funny how the narratives flip so quickly so if you did get seduced by that narrative in 2020 when Tesla was going to the moon and I also remember trying to day trade that and that wasn't fun either um you would have been in a lot of pain thinking oh you know EV is the future and I'm going to be in it it was a very tough five six years for most of the stocks related to ev i don't know how tesla has done um but it's been it's been something where man like you're you're just out there guessing almost like shooting blindfolded and hoping you hit something um be careful with these narratives yeah definitely and i mean that's so funny to hear because or not funny but interesting i guess uh because it just showed it goes to show you how fickle the market truly is that you know it's like it's like speech uh andrew throughout yolo which just goes to show you how big of a boomer he is because I don't think anyone said YOLO in like five years, six years.

32:46I don't even remember what it stands for now. You only live once. There you go. But I mean, no, all jokes aside, like that's literally how fickle the market is. One day is all it takes from something to be cool and hot. You know, right now, AI is the trend. Like everybody loves AI and AI is going to the moon. And then tomorrow, something cool comes out and literally AI is not even a second thought. It's like a fourth or fifth thought. And so, I mean, that I think speaks true 100 % to just why buying into the narrative is so dangerous. Because it will pay off for you for a day to maybe even a year or two.