Learning from Buffett: Winning & Circle of Competence

There were ~2,000 companies in the automotive industry in the 20th century. The market saw that cars were going to be a big thing. It was easy to see that the industry would be important. It wasn’t easy to pick which car companies would win because more than 90% failed. 

There were ~400 companies in the airline industry in the 1900s. Per Warren Buffett, Omaha, Nebraska was considered the hotbed of airlines—the Silicon Valley of airlines at the time. Not only did most of these companies not work out, Omaha’s fame as the place for airline innovation didn’t last. Please correct me if I’m wrong on this last observation.

It’s fair to say that Silicon Valley might not have the importance it has today in 50 years or even earlier given how fast change happens today. Sometimes, the industry is deemed important (like airlines) but the businesses within might not be great investments. 

An industry’s importance to humanity is exclusive from the players within being great businesses. Furthermore, the industry’s importance is one thing and knowing which companies will be the winners is another. Sometimes, the industry is just a fad and it goes away entirely. 

That’s to say, picking winners is hard. It’s already hard enough to pick winners in established industries today, let alone those that might win a promising industry. 

“I don’t know who’s going to win. Unless I know who’s going to win, I’m not interested in investing.”—Warren Buffett. 

Core to this is what Buffett repeatedly referred to as knowing our circle of competence as investors. It’s not the diameter of the circle but how well we know the boundaries and entirety of that circle of ours that matters.

The crux of it is whether we can know which companies are going to win. Picking companies that already look like they’ve won might be considered too obvious. I thought this way for quite some time, I may still think like this on some occasions.

But consider how hard it is to win in business. Business plays by the rules of capitalism. It plays in a complex environment with far too many variables. It’s not like most sports leagues with their fixed rules. In fact, many major sports leagues aren’t even capitalistic. 

Look at the NBA or NFL. They have salary caps, the worst teams get the best draft picks, etc. Those are socialist sports. It’s all about evening out the playing field for everyone. It’s surprising that a capitalistic country prefers its sports to be socialist in nature. It’s why dynasties like the New England Patriots are all the more impressive. 

Then consider leagues like Formula 1 (F1) or the English Premier League (EPL). They are capitalistic, despite predominantly in “socialist Europe”, compared to the U.S. The ones with the most money get the best players and they can compound their advantage. There are no limits. Bad teams are relegated (in EPL), get lower sponsorship revenue and lower payouts from the league (in F1). It’s capitalistic. You look at these leagues and it’s the same 2-3 teams that dominate the sport for a long time. 

That’s capitalism. It’s not supposed to be “fair” where everyone gets a turn or gets a shot. The winners will continue winning and that’s why they want to win in the first place. That’s what compounding advantages are all about. A business with a true competitive advantage will be able to widen its moat to make it harder and harder for incumbents and new entrants to compete with them. That’s what’s required of a wonderful business. 

Winning is difficult. It’s also hard to compete with those who’ve already won. The thing with survivorship bias is that we only see the new entrant that beat the one that’s won for a long time. But we forget the thousands that tried to take down the incumbent winner. 

The folly is the certainty people have that the next new entrant will be the one to win it all. It’s possible. But unlikely. 

The media likes to hype things up. Investors—especially those who invested in the upstarts—like to hype up the new players. Everyone loves cheering for the underdog. But why are they the underdog? Because the winners so very rarely lose. 

The true underdog was when Leicester City won the EPL. When the Philadelphia Eagles beat the New England Patriots, the system was doing what it was supposed to. We have to look at results by what the system was designed to do. 

It’s hard enough finding companies that have already won in industries that are important to humanity. Sure, there should be more “alpha” in doing the harder thing by trying to predict industries as well, but is it worth the risk of losing it all? At the end of the day, it depends on each investor’s individual wiring. 

The system needs those who will fund the upstarts that will challenge those who’ve already won. I’m realizing slowly that I may not have the stomach nor the wiring for such a world. 

Here is the interview I pulled the learning from: