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One of the core principles of Warren Buffett’s value investing system is Circle of Competence. That is, only buy stocks whose business you understand. If you don’t understand a business, how can you analyze it and come to an estimate of intrinsic value?

When Buffett invokes this principle he is usually referring to his own lack of knowledge about technology. For that reason, Buffett didn’t invest in Microsoft despite his relationship with Bill Gates and it wasn’t until he invested in Apple late in life that he bought his first technology stock. As a tease it is worth nothing that AAPL is perhaps Buffett’s greatest investment of all time and MSFT would have been a huge winner as well – and isn’t that hard to understand well enough to invest in either in my opinion.

Like Buffett, I’m a generalist with an education in the Humanities and Social Sciences and a lack of technical and scientific knowledge and know how. As a result, Technology stocks have always posed the same problem to me that they posed to Buffett.

But as I have gained experience and maturity, I have come to think that Buffett’s rule is too restrictive. For one, the Tech sector has grown so big that it dominates today’s stock market and many great businesses are Tech stocks. Two, understanding exists on a continuum. This is a point that I want to emphasize. While I may not understand Amazon Web Services as well as I understand their retail business, I still understand it well enough to invest in the stock.

The great Scottish Philosopher David Hume said that “A wise man proportions his belief to the evidence”. One way to apply this to investing in stocks outside one’s circle of competence is to use a smaller position size. While I might be completely confident backing up the truck were Walmart to be cut in half, I might only dip my toe in for Synopsys (SNPS) – which I did yesterday.

In sum, I believe generalists without a technical background like myself should be willing to invest in tech stocks outside of their circle of competence because (1) there is so much opportunity there that one is otherwise simply ignoring, (2) understanding exists on a continuum and (3) you can compensate for your lack of understanding by reducing your position size. For these reasons, I recommend value investors abandon the shibboleth of the circle of competence and venture into forbidden territory.

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Let’s now consider Synopsys (SNPS) in more detail. I bought shares yesterday after it got hammered on earnings while everyone was focusing on Oracle. I have known about SNPS for many years because a poker dealer at Casino M8TRIX, a technical investor who I am friendly with, was riding it up a while back. While I looked at the stock then and envied the chart, it was outside of my circle of competence and expensive to boot.

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But it’s been on my radar ever since and when the stock got destroyed yesterday after earnings, I decided to take a closer look. One thing that made me comfortable dipping my toe in is SNPS’s long history of success which can be seen by looking at a long term chart of its stock. That gives me confidence that this is not some fly in the pan operation but a great business that has done well for a long time and is therefore likely to bounce back.

In addition, SNPS operates in the semiconductor space which I am bullish on. I am an adherent of the cliche that “Chips are the new oil” even though my evidence for such a belief is more intuitive than evidentiary.

While I don’t understand how its design software is used in the making of semiconductors, its long track record, the size of the stock ($70 billion market cap) and its 2.39% weighting in the Semiconductor ETF (SMH) all provide circumstantial evidence that I am investing in a high quality business. I also follow some professional investors on Twitter who claim that it is as well.

Now let’s address some concerns. The reason SNPS got smashed yesterday is that they drastically reduced full year EPS guidance from $15.11-$15.19 to $12.76-$12.80 due to underperformance in their Design IP segment. In addition, even after the big drop SNPS is not cheap at more than 30x reduced guidance.

Weighing all of these factors, I decided to take a small position (-0.35%). While the business is outside my circle of competence, for all of the reasons outlined in this blog I am confident that doing so is a reasonable investment.

Had I not acted quickly during yesterday’s panic, I would have missed today’s 13% bounce which clawed back almost a quarter of yesterday’s decline. More importantly and from a larger and longer term perspective, I don’t want to completely ignore opportunities in the tech sector which has driven economic innovation for decades and is poised to do so for the foreseeable future.

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