Circle of competence

Warren Buffett's famous 'circle of competence' to me is a very important concept in relation to investing. I've briefly mentioned it in my opening blog statement (Buying $1 of assets for $0.50), but it's something which i believe needs more attention. Buffett defines a circle of competence (to my understanding) as a imaginary 'circle' which encompasses all of the companies in which he totally understands. The perimeter therefore, defines what businesses he totally understands and area exceeding this perimeter would be businesses in which he doesn't completely understand and won't invest in. As Buffett always says the size of the circle isn't important but being able to identify your perimeter is crucial. Knowing when a business is outside of the circle should prompt no further investigation as a investment.

I'm always trying to update my circle and I've found a definite business area which is outside this circle which is mining companies and exploration services. The reason why mining companies are outside my circle is because their cash flows are based on the price of commodities which to me are extremely difficult to forecast with a certain degree of certainty and thus i won't go near them. I don't think BHP even knows where the hell coal prices will be in 6 months, what chance do i have forecasting 10 years out let alone 1 month? Many people will disagree with this and that's fine but that is my reasoning. Exploration companies are (mostly) speculative plays, which i don't engage in and are way too capital intensive. Speaking about capital intensive businesses, Airlines are another area i won't get into and thus, are outside my circle of competence. This is because, they essentially, offer a commodity like product. And, to my understanding, commodity like products compete on price which is the last thing i want to happen (as price cutting will put downward pressure on margins, lowering profits and share prices). Despite Qantas' efforts to exert some sort of price coercion (through Flybuys for example)  price cutting still occurs. There's other reasons why i don't like airlines but i won't get into that in this post.

Telstra is another business which is out of my circle. This is because they haven't been able to drive earnings for the past 10 years. Now i know that alot of Australian investors like Telstra and that's also fine, but it's a company that i won't invest in (unless their earnings start to change to say the least).