Narrative Based Investing and Your Circle of Competence

How to Invest Like the Best - Part 1

Why narrative based investing?

Narrative based investing is essentially a systematized, repeatable, method to investing in any environment.

The process is as follows:

  1. Discover a business that you understand,
  2. Build your narrative around it as you get to know it further,
  3. Estimate the fair value of that business,
  4. Buy it when it is undervalued (or wait patiently until it is)
  5. Monitor that stock to make sure you only hold it if your narrative unfolds largely as expected.
  6. Then, when the narrative has either finished unfolding, or is no longer valid, sell the stock and move on to the next idea.

The “narrative” is essentially your assessment of the current business, and your estimates of where it could be in the future. Answering a question like “Where do I think this business is going to be in 5-10 years time, and why?” is the basic premise of a narrative.

A very brief example of a narrative is:

Based on my research, I believe stock X is going to have 40% market share of the $100bn Y industry by 2032 (i.e $40bn revenue). I believe it will be above its competitors because its current competitive advantage of “Z” will help it maintain its dominance in the future. With this in mind and other assumptions, I think the business could be worth $Xbn in 2032, and since it’s currently priced at half that value, I think it’s undervalued based on its future prospects.”

The entire Simply Wall St platform is built around this process, and throughout this series we’ll show you how it helps you build your narrative.

Now, an important point is, you can only build a narrative around a stock by getting to know the ins and outs of the underlying business.

So, how can you find businesses that you already know a lot about? Start by looking within your circle of competence.

What is your circle of competence?

Your “circle of competence” is any product or service that you have an in-depth understanding of. Think about products or services you already use, and ones where you know what makes them better than others.

  • Do you love certain subscriptions over others due to the available content?
  • Do you choose certain apparel brands over others because of the quality and brand?
  • Did you choose a bank over others because of the user experience?
  • Did you choose certain tools at work because they’re more reliable than others?
  • Do you shop at some supermarkets because they have the best prices?
  • Do you use some social media apps because all your friends are on there?

Why start in our circle of competence?

There are many reasons to only look for investments within your circle of competence (like Buffett does), and here are three:

  1. It helps you avoid those costly mistakes of investing in things you don’t understand
  2. You already know what makes one product or service better than others
  3. Since analyzing a stock is essentially analyzing a business, and you already know the business, you’re halfway there.

Circle of competence
Circle of Competence

So in your own time, fill out this table below to get an idea of where you have some experience already.

What do I spend my money on?

  • Reading books, listening to music/podcasts, watching movies

What am I passionate about?

  • Sports Cars, Health and Fitness

What is my line of work?

  • Finance, Remote work, Writing

Now that you’ve answered the questions above, it’s time to list what companies are the owners of those products and services you use or know?

What do I spend my money on?

  • Amazon (AMZN), Spotify (SPOT), Netflix (NFLX)

What am I passionate about?

  • Ferrari (RACE), Tesla (TSLA), Lululemon (LULU)

What is my line of work?

  • Mastercard (MA), Apple (AAPL), Google (GOOG), Zoom (ZM)

Once you know which companies you use above that are also publicly listed as stocks on the stock market, you can then add them to your Simply Wall St Watchlist!

Now that you have a bunch of stocks on our radar that you’re familiar with, let’s get to know them a little better in Part 2!

In Part 2: Get to know the business, you'll find out exactly where to look to get up to speed on these businesses in your watchlist!