Discovering Our Investor Circles of Competence

Plus, my journey from a top-down macroeconomic growth speculator to a bottom-up quality-driven value investor

Rational, disciplined, and patient investors discover their circles of competence in the sectors and industries that house the common shares of their targeted companies.

Financial media often quote Warren Buffett and the late Charlie Munger of Berkshire Hathaway ($BRK.B) for a shared commitment to investing within their “circle of competence” by buying what is known and understood. In other words, first, read for discovery and then apply cognitive thought when allocating hard-earned dollars to an investment portfolio.

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Discovering Our Investor Circles of Competence

Be committed to a thoughtful approach to quality-driven value investing.

The mantra includes understanding and accepting the limitations of our circles of competence as we avoid the crowd’s bias toward low-quality, expensive investments in businesses, industries, or sectors with hard-to-understand models.

For example, professional portfolio managers tend to favor financials more than other sectors. They participate as full-time members of the financial services industry, and the sector presents itself as an investment comfort zone—or unique circle of competence—by default. As a result, they develop narrow spheres of expertise that define their success in specific market niches.

My circles of competence—developed from over twenty years of retail-level investing—are restricted to six sectors: communications services, consumer discretionary, consumer staples, health care, industrials, and information technology.

• The communications services sector spun off from the consumer discretionary and the former telecommunications sectors and now includes the original holding in our family portfolio: The Walt Disney Company ($DIS)
• Consumer discretionary sector companies consist of predominantly easy-to-understand products and services, although at higher risk because cyclical stocks dominate the space.
• The consumer staples sector also covers easy-to-understand products or services, but, as noncyclical businesses, at a presumed lower risk.
• The health care sector is to twenty-first century America what the automobile industry was to the twentieth century—the centerpiece of the domestic economy.
• Industrials sector companies manufacture things an everyday investor can understand for the most part.
• It is sometimes challenging to comprehend the products and services of information technology sector companies. However, the value propositions are often compelling.

By choice, I bypass the other five sectors. Here is why I avoid each:

• Financials are often too leveraged and overinvested by Wall Street. The exception is our family portfolio holding in Berkshire Hathaway, which is more of a multi-sector investment than a purely financial one.
• Real estate investment trusts (REITs) predominate in the real estate sector. Since a significant allocation of our family’s net worth is home equity, I would only include quality REITs in my portfolio if I were a renter or retiree.
• Energy stocks tend to go up and down with energy prices more than the performance of the representative companies.
• Materials are volatile, commodity-based stocks. See Energy above.
• Utilities are overregulated and often too leveraged, although perhaps a wise choice for retirees seeking income diversification.

In addition, I focus research on major-exchange large, mid, and small cap stocks while avoiding microcaps and over-the-counter (OTC) issues as speculative.

Staying within our circle(s) of competence is a sage method to help protect our invested capital. Always ask, what sectors or industries are within our sphere of confidence? On the contrary, which should we avoid or leave to professional money managers with histories of generating alpha in their areas of expertise?

My Journey as a Common Stock Investor

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About the Author

David J. Waldron is the founder and contributing editor of Quality Value Investing, and author of the international-selling book Build Wealth with Common Stocks. David’s mission is to inspire the achievement of his readers’ financial goals and dreams. He previously enjoyed a 25-year career as a postsecondary education administrator. David received a Bachelor of Science in business studies as a Garden State Scholar at Stockton University and completed?The Practice of Management Program?at Brown University.

Unless noted, all data presented was sourced from Charles Schwab & Co. as of the market close on November 4, 2024, and intended for illustration only.

Disclosure:?As of the date of this research report, I/we held long beneficial positions in BRK.B and DIS common shares in our family portfolio. I wrote this report myself, and it expresses my own opinions. I am not receiving compensation for it other than from Substack paid subscriptions. I have no business relationship with any company whose stock is mentioned in this post.

Additional Disclosure: Quality Value Investing by David J. Waldron’s primary ticker research reports are for informational purposes only. The accuracy of the data cannot be guaranteed. Narrative and analytics are impersonal, i.e., not tailored to individual needs nor intended for portfolio construction beyond his family portfolio, which is presented solely for educational purposes. David is an individual investor and author, not an investment adviser. Readers should always engage in independent research or due diligence and consider, as appropriate, consulting a fee-only certified financial planner, licensed discount broker/dealer, flat fee registered investment adviser, certified public accountant, or specialized attorney before making any investment, income tax, or estate planning decisions.

Copyright 2024 by David J. Waldron. All rights reserved worldwide.