How to Expand Your Circle of Competence

“Know your circle of competence, and stick within it. The size of that circle is not very important; knowing its boundaries, however, is vital.” – Warren Buffett

The circle of competence is one of the most widely used terms in investing. And an investor is supposed to invest within it. But for someone who is new to investing, this task can be daunting. I remember when I was new to investing, I looked at all the companies that existed and realized I pretty much only understood retail companies. That’s depressing. And it’s probably the situation a lot of new investors find themselves in.

Here is what is not said about your own circle of competence – you can grow it and expand it. Here’s a step by step guide to how I expanded my circle of competence and added the airline industry to my circle of competence.

I never wanted to add the airline industry to my available investments, but it just kind of happened. In fact, why would anyone want to invest in airline stocks? With the exception of Southwest Airlines (NYSE:LUV), airline stocks have been a terrible investment. Almost without exception, every airline not named Southwest has declared a bankruptcy in the past. This includes heavyweights like Delta Airlines (NYSE:DAL), United Airlines (NASDAQ:UAL), and American Airlines (NASDAQ:AAL). Despite that, here is how airline investments came into my circle of competence through some luck and research.

  1. I had a friend in the industry I learned about who was willing to share a lot. An old friend of mine has a private pilot’s license and I went with him in his Cessna a few times both when he still flew with an instructor and without one. There is a lot you can learn about private pilot instructors talking to their students when it looked like becoming a commercial airline pilot for one of the “Big 4” is the equivalent in their industry of making it to the major leagues. From this, I picked up all kinds of tidbits you would NEVER find in an annual report, but makes an impact on the service received.

For example, I learned that Southwest taxis while on the ground much faster than all other airlines. I learned there is a hierarchy in terms of making it to the “big leagues” for commercial pilots. In fact, it was a lot like the minor leagues. Instructors had to start out giving lessons and if they were lucky they’d get the call up to a regional airline. From there only the truly exceptional could make it on the big carriers. It was fascinating!

  • I read books about the industry. For example, there is a great book called Nuts! that goes into detail about Southwest and their unconventional plans for success in such a tough industry. Mohnish Pabrai on a podcast episode laid out a case for why he chose to invest in Southwest. Buffett has a lot of writing about how much he hates airlines. He also owns stakes in all the major airlines now. There is a lot to learn about the trends in airlines and how deregulation and consolidation of the carriers made what was once a bad industry to invest in now offer a different proposition that some see as attractive and others still see as bad.
  • I read annual reports. There is no way around this. You will learn so many things you will never learn otherwise. You’ll learn about the different planes each company carries, their operating philosophies (hub and spoke vs point to point), and labor situations. If you refuse to read annual and quarterly filings, you’ll never make it.
  • I talked to more people in the industry. You never know who you’ll meet. Once on a Southwest flight I met a man who worked for 30 years building aircraft parts for all the major carriers. I asked him a simple question: “If you had to invest all your money in one of the big four for the next 10 years, who would it be and why?” He responded with Delta because they were the best managed. I couldn’t resist asking him why if he thought that he was on a Southwest flight. He smiled and told me “because I like that bags fly free.”

Expanding your circle of competence takes time. In fact, you are delusional if you think you can learn a new industry in less than a year. But the return on this is enormous. You can add a whole new industry to your investment world. Imagine now having an additional 10-15 stocks where you can invest when the valuations look in line and it requires very little work because you laid the groundwork years prior. Building a circle of competence and expanding it isn’t hard, it’s time consuming. But it’s worth every ounce of work.

Buy Nuts!:

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