Circle of Competence

When it comes to the stock market, there are just so many stocks to choose from that sometimes, we get overwhelmed in choosing what to buy. Add to this the funny reality of money burning a hole into our pockets...

I must buy something! But what?!?

I don't know if the above holds true for you when my money clears into my brokerage account, but it is true for me.

Based of these, lets try to categorize the type of stocks in the Philippine Stock Market.

First we have the companies known as blue chips. These are the companies listed on the PSE composite index. They are somewhat the leader companies of their sector. There are 30 in all in the PSEi. These stocks are chosen to be in the index due to their stability.

To name a few: Ayala Corp (AC), PLDT (TEL), Aboitiiz Power (AP)

Next are called the 2nd liner stocks. These are stocks that are popular or well-to-do companies that are not part of the Index but are still popular due to the size or profitability of the company.

To name a few: Cebu Pacific (CEB) used to be in the index but was downgraded to 2nd liner, EEI, NICKL

The last grouping of stocks are known as the third-liners. These stocks are what U.S. Brokers would call penny stocks. They're called penny stocks because most of the share prices of these stocks are in centavos.

To name a few: OV, APM

Even after we've grouped them, there are still a lot of stocks to pick from even if we base our choices from the Index alone. The index holds 30 stocks. If you want, you can buy 1 boardlot of each company in the index. But then this would counter what we call as Focus Investing.

Focus investing concentrates our capital on 3 stocks for our portfolio, with 6 being the maximum allowable number.

So how do we pick 3 out of 30? Quite simple. We just follow our circle of competence.

Imagine yourself as the center of a circle. As you go about your day-to-day tasks, you interact with people, commodities, services, etc.

For example, your house uses Veco for electrcity. You buy your groceries from SM, or your house sits at an Ayala developed land.

This is your circle of competence. Investing in what you know.

Peter Lynch of Magellan Fund (the most successful Mutual Fund in U.S. history) discovered Taco Bell because while on a trip in California, he was hungry and saw a Taco Bell stand. So he parked his car and had a snack there.
Warren Buffett bought Fruit of the Loom (company that makes underwear) because he liked the brand and had used it.

From this, observe your circle of competence and buy stocks accordingly.

Do you go on trips using Cebu Pacific?

Do you put your savings into Banco De Oro?

Do you drink San Mig Light or San Mig Coffee 3-in-1?

Is your cellphone network Globe?

Do you like eating in Jollibee?