Someone who reads my blog emailed me this question:
“What is the best way to grow a circle of competence in a given field? Is it reading a bunch of annual reports? Is it trade magazines? Is there an online resource that provides detailed education on different industries?”
The best way is picking specific stocks to study. A lot of people do too much what I’d call “passive” learning They hope to be like a sponge reading Warren Buffett (Trades, Portfolio)’s letters, “The Intelligent Investor,” a new book on some economic issue, a book on behavioral finance, etc. And they do this without a pen, paper, and calculator in hand. They don’t ask questions. They don’t make the subject their own. They are too detached and objective about it. The right way to increase your circle of competence is not about what you choose to study. It’s about how you choose to engage with that material.
Here’s what I’d suggest to investors who wants to grow their circles of competence. First, think of the stock in your portfolio you know best. The business you are most comfortable with. I don’t own Omnicom (OMC, Financial). But I have in the past. Let’s use that as an example. Omnicom has some obvious public peers: Interpublic (IPG, Financial), Publicis (XPAR:PUB, Financial), WPP (LSE:WPP, Financial) and Dentsu (TSE:4324, Financial). That’s five companies right there. There are plenty of other companies we could talk about. We could talk about Havas (XPAR:HAV, Financial) and BrainJuicer (LSE:BJU, Financial) and so on. But five is enough.
Now, make yourself a schedule. Time yourself. Most people spend too much time with too divided an attention. They don’t focus enough on the subject they want to study. You probably don’t know how long it takes you to read an annual report. A lot of people have no idea how quickly they read. Do you think you read at 150 words a minute, 300 words a minute, or 450 words a minute? Some people have no idea. There’s no reason not to know this. It’s easy to figure out what a normal pace is. How many pages there are in an annual report may determine how long it takes you to read the report. But we can use a sample of these five stocks and the median result of how long it takes you can be a pretty good guide to how long it will normally take you.
Set yourself a schedule. For the next five days: read the annual reports of Omnicom (Monday), Interpublic (Tuesday), Publicis (Wednesday), WPP (Thursday) and then Dentsu (Friday). You have no idea how long it will take you to get through each annual report. So, this time you’re going to need to set aside a lot of time. You might need something absurd like a block of three hours each day this first time. But you’re only going to need this once. After we have the timed results of these five annual reports, you’ll be able to measure how long it normally takes you to get through an annual report.
Set a timer. I have an Amazon (AMZN) Echo where I work. But you can use a phone. Or, you can use a computer. My one caution about using a computer is that I’m going to have you print out the annual report. I don’t want you reading the annual report on the computer. That only encourages distraction.
The tools you are going to need are the 10-K or annual report itself, a calculator (for your hand, not on your phone or computer) and a pen (to write notes). I have a pad of blank paper with me (it’s just printer paper clipped to a clip board) at all times. Other people just write all over the 10-K itself. I think this is how BuffettÂ does it. I will write questions on the 10-K or circle things. When I want to do longer calculations I use a blank sheet of paper to write down the values with which I am working.
The most important thing is the questions you ask. This is directing your attention. The “experience” of reading an annual report is not objective. It’s subjective. As you work your way through an annual report and I work my way through an annual report we are going to have different experiences. We are going to notice different details. We are going to ask different questions. It’s important to ask questions to which you don’t know the answer. It’s even OK to ask questions you can’t answer and aren’t sure how to get the answer just yet.
I have Asperger’s. Compared to other people unusual details are going to pop out to me. The average person is going to tend to see the “forest” more and the individual “trees” less. If you give average people columns of numbers or paragraphs of text, what jumps out to them is more like “what’s the overall theme here, what’s the purpose of this stuff” whereas what jumps out to me are the individual errors in arithmetic, spelling, etc. Unusual details.
There are advantages and disadvantages to integrative versus disintegrative (analytic) thinking. Different people will fall in different places on this spectrum. Some people are very detail oriented. Others are very gist oriented. Even if you are gist oriented, you’re going to want to zero in on the specific details that tell you more than what the company is trying to communicate. Usually, you aren’t going to be good at picking out specific details and drawing analogies between companies until you read the reports of several different companies that are related in some way. Write down all the questions you have as you have them. And work your way through all five of the ad agency groups I mentioned. Time yourself.
Now that you know how much time it takes you on average – let’s say it took you between 60 minutes and 120 minutes to work your way through each annual report and the median time was 80 minutes. In the future, I’d definitely set a timer for 120 minutes when picking up an annual report. And I’d seriously consider setting the timer for more like the median (in this hypothetical, 80 minutes) time. This is to ensure you stay focused. Most people aren’t able to stay focused for long periods of time. It’s unrealistic for the average person to spend more than maybe three to four hours of their day actually focused. And they are rarely going to be able to sustain focus for longer than 90 minutes. Work periods of more like 45 minutes to one hour are more reasonable. If you can find a way to break your study time down into one-hour chunks, I’d definitely do that.
Know ahead of time the exact task you are going to tackle and then set a timer for the time you are going to work. If you finish before the timer – fine, you’re done. If you don’t finish before the timer – you’re still done, at least for today. Be realistic in setting the timer. The idea is not to rush. I’m not trying to get you to read an annual report and take notes, ask questions, etc. as quickly as possible. What I’m trying to get you to do is to be 100% focused on the work you’re doing while you’re doing it. This is critical. That’s why you are working from a printout. Otherwise, you will have tabs open in your browser, you might even check email, take a call, etc.
There is no substitute for focused attention. That means focus in terms of not doing anything else while you are working on studying some investment. But, it also means focus in terms of what you are studying. I don’t want you “thinking about the market” willy nilly. Or about advertising. Or about anything as broad as that. On Monday, you are going to think only about Omnicom. On Tuesday, you are going to think only about Publicis. And so on. You are also going to be alone with the primary source and your own thinking. I don’t want you reading anything I wrote about Omnicom, or something written about ad agencies over at Value Investor’s Club, or anything as mentally undemanding as that.
You are doing focused work here. Mental heavy lifting. It’s a lot more pleasant to read other people’s ideas and then either nod or shake your head on the inside. This doesn’t lead to any insights. It doesn’t help you come up with your own way of seeing stocks, companies, situations, etc. You have to be focused. And you have to be alone with your own thoughts to do this. I can’t stress this enough. This is the sort of thing that I’m sure BuffetÂ does and that I’m sure almost everyone I talk to via email does not do. There are plenty of people who spend as much time as BuffettÂ thinking about investing. But, they don’t spend as much quality time. The quality of the time you spend is the focus you bring to bear on some specific question.
OK. This isn’t supposed to be a discussion of focused work; it’s supposed to be a discussion of circle of competence. How do you expand it? First, you verbalize things. You actually write your questions right there in the margins. You make the material your own. The 10-K itself isn’t important. The way you see and frame and understand the 10-K is what matters. Every 10-K you read changes you.
Once you detect a possible opportunity – you can work in a web of familiarity. For that first week, I gave you a rather rigid schedule. It’s organized in terms of genre. The genre here is industry and its big, giant, public ad companies. You are going to read about Omnicom, Publicis, WPP, Interpublic and Dentsu. This isn’t necessarily the best way to increase your circle of competence. But it’s a fine way to start. It’s an easy category to identify. When I was writing a newsletter, my co-writer and I did this a lot. We looked at Grainger (GWW) and MSC Industrial (MSM) back to back. We looked at U.S. regional banks like Frost (CFR), Prosperity (PB), Bank of Hawaii (BOH), BOK Financial (BOKF) and Commerce (CBSH). A lot of times one bank would lead us to another.
For example, I liked Frost. Frost is the biggest bank in Texas. Quan liked Prosperity. Prosperity is the second-biggest bank in Texas. Frost and BOK Financial are two of the biggest energy lenders around (one is in Texas, the other is in Oklahoma). Frost and Bank of Hawaii are similar in terms of having very high deposits per branch. That’s a figure I care a lot about.
We also looked at Wells Fargo (WFC). In some ways, Wells Fargo is like a nationwide regional bank. It looks a little like Frost and Bank of Hawaii in some ways but not in other ways. And there were enough differences that we never picked Wells for the newsletter. But we had an established process for looking at these banks. And we got better at that process as we went. The two huge advantages we had though were that we talked about these banks and we wrote about these banks. I can’t overstate how important verbalizing your thinking process is.
If you can find someone to talk your investment ideas through with, do it. BuffettÂ had his Charlie Munger (Trades, Portfolio). Get one. Maybe there’s a blogger you really like. Email him. Ask him what he thinks of some idea of yours. It’s not real important what he says. Don’t act like he’s an expert and you’re a newbie and you are seeking guidance from him. Act like he’s a peer and you are pitching an idea. It doesn’t much matter if he emails you back, likes your idea, etc. The key here is to hear yourself talk the idea aloud. Everybody needs a sounding board. You need someone to bounce ideas off. Who that person is doesn’t matter. What matters is hearing yourself talk aloud.
If you aren’t writing a blog, you should be. If the whole blog idea doesn’t appeal to you, start an old school journal, but get out a piece of paper and write down why you are buying the stock. Give your reasons.
Maybe you aren’t ready for any of that yet. Maybe you just want to focus on “studying” to increase your circle of competence. That’s fine, but don’t let it be passive study. And don’t let it be unfocused. Most people are too passive and too scatterbrained in their study of value investing. Pick a group of stocks. I mentioned multinational ad agency holding companies. I mentioned regional banks. I mentioned MRO distributors. Fastenal (FAST) is another one. So, if you want to study MROs – there are three to get you started: MSC Industrial, Grainger and Fastenal. You don’t have to decide if any of them are worth buying.
But you can certainly read the latest 10-K of each of these three companies and then you can write a blog post or a journal report explaining which you think has the best: 1) business model, 2) growth prospects, 3) customer base, 4) capital allocation, 5) management and 6) stock price. If you had to buy one of these three stocks, which would it be? If you had to short one of these three stocks, which would it be?
Here are some clusters of stocks to study.
Watch stocks: Movado (MOV), Fossil (FOSL), and Swatch (XSWX:UHRN).
Bank stocks: Frost, Prosperity, BOK Financial, Bank of Hawaii, Commerce Bancshares, UMB Financial (UMBF) and Wells Fargo.
MRO distributors: Fastenal, Grainger and MSC Industrial.
Advertising giants: Omnicom, Publicis, WPP, Interpublic and Dentsu.
Pick any of these groups. Work through one annual report a day for three to seven days of study. Talk to another investor. You can do this in person, on the phone, via Skype or via email. Talk to me if you want. I promise I’ll read your email – no matter how long – and I’ll send you some kind of answer in return. Then, once you’re done studying a group of these stocks and done using another human as a sounding board, put your own reasoning down on paper. If you’re shy, put it in a pen and paper journal that no one else ever needs to see. If you’re more gregarious, put it in a blog post. Turn the comments off or learn not to read them. You don’t need to hear people’s superficial, knee-jerk reactions to what you write. It’ll dispirit you. How other people judge your ideas isn’t important. That’s not the point of the exercise. The point of the exercise is to get comfortable hearing yourself think.
Of course, there’s nothing magical about 10-Ks. Some investor presentations are pretty good. If you want to make more work for yourself, I’d suggest reading both the latest annual report and the latest investor presentation (not a result presentations – but like an Investor Day or an investment banking conference or something similar). Don’t read the earnings transcripts. I do read earnings transcripts. We used these heavily in the newsletter I wrote. But, what we’d do is work from a huge stockpile of like 5-10 years of past transcripts and take a long-term view. This is very time intensive. There’s no point reading the latest earnings call transcript or listening to an earnings call. Just work from 10-Ks (or annual reports) and investor presentations. Study stocks in groups.
My four rules for expanding your circle of competence are:
- Study a series of related stocks.
- Give each stock your absolute undivided attention – focus like you’ve never focused before (it’s fine if you can only do this for like 45 minutes at a time).
- Put your thoughts into writing.
- Bounce those ideas off another person.
Once you get through these four steps, you’ll have a ton of questions; you’ll be so energized by the discussion that you’ll be ready to go right back to Step 1 with a new group of related stocks. You’ll be talking about some aspect of banks and the other guy will tell you about how that’s similar to something he saw with this insurer. Once you get a discussion going, you’ll find a lot of new threads to follow. Just stay focused and stay engaged. And try to do a little every day.
If you can devote even 30 minutes of total focus a day to this task – you can grow your circle of competence. That’s over 180 hours of intense study in one year. It’s much better than looking at stocks and markets randomly in unfocused dribs and drabs as headlines come in. Expanding your circle of competence doesn’t take much time. It does take dedication. Make it a focused, daily habit.
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