In this Q&A session at Boston College and Harvard Business School, Mohnish Pabrai discusses the importance of understanding one’s circle of competence when evaluating businesses. He advises focusing on industries and companies that align with personal knowledge and avoiding sectors like biotech, blockchain, or U.S. healthcare, which may involve complexities or non-market forces.
He highlights Warren Buffett’s principle that staying at the center of one’s competence is more crucial than its size.
Once within this circle, one should analyze a company’s trajectory, capital requirements, return on equity, and the quality of leadership. This disciplined approach helps determine whether a business is worth deeper exploration or investment of time and resources.
Here’s an excerpt from the session:
Pabrai: Yeah, actually what I said is that if you open Excel, there’s a problem. Spend time on it. Just even open Excel.
If you’re looking at a business and you can’t do the math in your head, then I think there’s a problem. The mental models—the first thing that goes through is: you’ve got to really be honest about your circle of competence.
Got a business, and you say, “Okay, this is something I understand,” or, “I don’t.” I don’t understand anything about biotech. I don’t want to deal with the defense sector because it deals with one customer or a few customers—I don’t like that.
I don’t like the healthcare industry in the US because it has non-market forces working on it. So there are entire areas that I just don’t understand.
Anytime I encounter something with blockchain—that’s way above my pay grade—so it’s gone. A lot of things just go away.
I think the important thing is, like Buffett says:
The size of the circle is not important; staying in the center is very important.
So, the first question is the circle of competence.
If you feel that something is within your circle of competence, then, by definition, we should be able to figure out what its likely trajectory is going to be.
Then you look at:
- What kind of low return on equity or high return on equity does it have?
- Does it need a lot of capital, or doesn’t it?
- What kind of person is running it?
- What kind of capital allocator do we have?
There are all these different things to figure out whether you want to spend time on it.
You can watch the entire session here:
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