It was a Saturday afternoon some weeks ago, and we were a Foolish quartet who were hungry for some chicken rice. After a debate on the place to satisfy our cravings, we settled for a “place-that-shall-remain-unnamed” (no, we were not at Voldemort’s chicken rice store). Once we settled down at the table, our hungry tummies started taking charge and we ordered the restaurant’s signature chicken rice as well as a good number of side dishes to go along with it. As we waited – fork and spoon in hand – for the dishes to arrive after…
It was a Saturday afternoon some weeks ago, and we were a Foolish quartet who were hungry for some chicken rice. After a debate on the place to satisfy our cravings, we settled for a “place-that-shall-remain-unnamed” (no, we were not at Voldemort’s chicken rice store).
Once we settled down at the table, our hungry tummies started taking charge and we ordered the restaurant’s signature chicken rice as well as a good number of side dishes to go along with it.
As we waited – fork and spoon in hand – for the dishes to arrive after a good 45 minutes, some unexpected news came along. The waitress sheepishly informed us that it would take another 45 minutes for the side dishes to arrive, as the chef had just arrived at work. Aghast with this new development, we enquired about the availability of chicken rice.
Thankfully, there was a saving grace here.
The store still had chicken rice to serve. It occurred to us that it was a good thing to have chicken rice available when the sign at the store says so. After all, chicken rice should be the store’s core competence.
So, a mini-crisis of Foolish cravings was averted.
And speaking of a crisis, there was certainly one going on for Warren Buffett in the year 2000 at the height of the dotcom mania. That year, Fortune bravely suggested that the Oracle of Omaha may has lost his “heavenly touch”. It also hinted that his stubborn insistence on investing in proven businesses was going out of style. Even Buffett jokingly commented that “value investing hasn’t been working so hot lately”.
Despite the animosity, Buffett was steadfast in term of his actions. He continued to insist on investing in companies which he knew best and shunned the hot technology shares – some of which were even losing money by the boatloads – which were all the rage.
Dotcom bubble bursts: NASDAQ falls close to 80%
As the dotcom bubble burst, Buffett’s stubborn discipline paid off. From 2000-2002, shares of Berkshire Hathaway (the conglomerate which Buffett controls) gained 29% while the tech-stock heavy NASDAQ index in the USA fell by close to 80%. For me, this significant 109% comparable outperformance brought home the importance of one particular investing concept.
And, this concept was one which the Oracle often refers to as the “circle of competence”.
Stay in the circle
Simply said, the circle of competence can be defined as an area (typically, companies or industries) in which an individual has a comparable advantage in terms of expertise or knowledge. The easiest place to start may be your line of work.
As an example, a dental practitioner in Singapore might be better versed in the business of Q&M Dental Group (Singapore) Limited (SGX: QC7), a dental healthcare services provider. Since the company was listed in Nov 2009, its shares have returned 256% as of yesterday’s closing price. In contrast, the STI ETF (SGX: ES3), a proxy for the Straits Times Index (SGX:^STI), had returned a little over 18% for the same timeframe.
Conservative value investors, though, may balk at the trailing price-to-earnings ratio (PE) of 42.5 for the dental group. In comparison, the STI ETF currently trades at a PE ratio of only 13.9. Q&M Dental Group’s balance sheet might also not appeal to that same group of investors; the company carries S$14.3 million in cash with total borrowings of S$20.4 million.
The Foolish Take Away
To bring this back full circle, it was perhaps better for the chicken rice store to do what it did best, that is, to provide a tasty meal of succulent chicken and fragrant rice – especially when there are hungry Fools around. As the Oracle of Omaha would say, it is not the size of the circle of competence that matters, but rather awareness of the perimeter of your own circle of competence.
Whether it is a set of companies which you have followed for years, or industries which you may have additional insight on, it pays to be highly aware of where you have a comparable advantage in. If you are able to do that, you might just be one step closer to the kind of comparable outperformance which Buffett has shown over the long term.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong owns shares in Berkshire Hathaway.