One of the most important things I've learned over my years as an investor is that my circle of competence doesn't just limit what I should invest in—it shapes how I analyze and seize market opportunities. Having a well-defined circle of competence allows me to cut through the noise, understand the true drivers of value, and make decisions that are based on knowledge rather than speculation. Today, I want to share how staying within my circle has helped me identify market opportunities that others might have missed, and how you can do the same.
The Power of Knowing What You Know (and What You Don't)
My circle of competence has always been rooted in industries like technology, software, and consumer goods. These are areas where I’ve worked, studied, and built deep expertise. I also have a degree in computer science, which gives me a unique perspective on the tech and software sectors. Because of that, I’m more comfortable assessing opportunities in these spaces and understanding what creates value for companies.
In 2014, I came across an opportunity in the software sector. The company was a mid-sized software firm that had been around for over a decade, but its stock was trading at a low price-to-earnings (P/E) ratio of 12. Most investors were worried about competition from newer tech players, but because software was within my circle of competence, I knew that this company had a strong base of loyal customers and a reliable recurring revenue model. I also understood the scalability of their software solutions, which had a potential for margin expansion.
I dug deeper into the financials, analyzing their recurring revenue growth and customer retention rates. The fundamentals were strong: the company had high gross margins of around 80% and a customer retention rate of 95%, indicating that their customers were highly satisfied and unlikely to leave. I recognized that the market was overreacting to the threat of competition, and I saw a great opportunity to invest. I bought in, and over the next three years, the stock rose from $50 to $100. My understanding of the industry helped me see value where others saw risk.
How Your Circle of Competence Helps You Spot Opportunities
Having a well-defined circle of competence means that you can filter out the opportunities that aren’t worth your time and focus on the ones that are. In my experience, this is one of the biggest advantages of staying within your circle—you know what to look for and where to look.
For example, during the 2018 tech correction, many tech stocks saw significant declines due to fears of regulatory scrutiny and rising interest rates. One area that I knew well was enterprise software. The market was punishing software stocks across the board, but I knew from my experience that companies with high recurring revenue and strong customer loyalty were less vulnerable to short-term economic fluctuations.
I analyzed one particular software company that had been hit hard but had a strong history of subscription revenue growth and a robust client base of Fortune 500 companies. The stock was trading at a significant discount compared to its historical valuation, and the company’s net dollar retention rate—a key metric in the software industry—was consistently above 120%, indicating they were expanding their revenue within existing customers. I invested in the company, and as the market began to differentiate between the strong and the weak players, the stock rebounded by 75% within a year.
Staying Focused: The Key to Avoiding Distractions
The market is full of opportunities, but not all of them are right for you. I’ve learned that trying to chase every opportunity, especially those outside my circle of competence, can lead to poor decisions and costly mistakes. There was a time when I got caught up in the hype around electric vehicle (EV) companies. It seemed like everyone was making money, and I didn’t want to be left behind. But I quickly realized that I didn’t understand the intricacies of the EV supply chain, the challenges of scaling production, or the regulatory landscape well enough to make informed decisions.
After some reflection, I decided to step back and refocus on what I knew best. I put my energy back into analyzing software and tech companies, and that decision saved me from potential losses when some of the more speculative EV stocks experienced significant volatility. Staying focused on my circle of competence has helped me avoid distractions and concentrate on the opportunities where I have a real edge.
Expanding the Circle—Carefully
While it’s crucial to stay within your circle of competence, that doesn’t mean you shouldn’t try to expand it. I’ve expanded my own circle over time, but I’ve done it carefully and deliberately. For example, I became interested in the cloud computing sector a few years ago. I didn’t rush in—I spent months reading industry reports, talking to experts, and studying the business models of different cloud service providers.
I started small, investing in a company that had a proven track record of innovation and a strong balance sheet. As I became more comfortable with the industry dynamics—like the importance of scalability and the role of infrastructure as a service (IaaS)—I gradually increased my investments. Today, cloud computing is part of my expanded circle of competence, and I feel confident analyzing opportunities in that space.
The Lesson: Expanding your circle is possible, but it requires time, effort, and humility. You have to be willing to learn and accept that you won’t become an expert overnight. Start small, gain experience, and gradually build your understanding.
Practical Tips for Leveraging Your Circle of Competence
Know Your Strengths: Take the time to define your circle of competence. What industries do you know well? Where do you have a deep understanding of the drivers of value?
Filter Opportunities: Use your circle of competence to filter out opportunities that aren’t worth pursuing. Focus your energy on areas where you have an edge.
Expand Gradually: If you’re interested in expanding your circle, do it slowly. Learn as much as you can, start small, and be patient.
Stay Disciplined: It’s easy to get caught up in the excitement of a new trend or hot sector. Remind yourself of what you know and stick to it. Avoid the temptation to chase opportunities that are outside your expertise.
Conclusion: The Circle Shapes How You See the Market
Your circle of competence is more than just a limitation—it’s a powerful tool that shapes how you see the market and analyze opportunities. By focusing on what you know, you can identify value that others miss, make informed decisions, and avoid costly mistakes. It’s not about knowing everything—it’s about knowing enough to make smart, confident choices.
In my experience, the best opportunities often come when you stay true to your strengths while gradually expanding your knowledge base. By leveraging your circle of competence, you can turn market opportunities into successful investments, time and time again.