Rule #1 Finance Blog

With Investor Phil Town

RULE #1 QUESTION OF THE WEEK: WHAT IS A COMMODITY STOCK?

Somehow Monday came and went and I forgot the 9 a.m. post.  Here it is, with my apologies. David had a question about how to identify a commodity stock. Read on:

Hi Phil,

Here's a question that you may want to touch on in a blog entry. I know
Rule #1 investors do not trade in commodities so I recently dropped UNT
because it is resource based (thankfully at a small profit). I am
wondering what constitutes a commodity in your eyes. I've been reading
Robert G. Halstrom's "The Warren Buffet Way." He includes (p.71 )
automobiles, computers, airline service, banking and insurance as
commodity-type stock. Based on Halstrom's assertion, I imagine we
should stay away from Honda (HMO) or IBM even if they had excellent
numbers and their share prices fell to an acceptable MOS. Would you
agree?

David Brien

Here's what I told David:

Hi David,

A commodity stock has several key attributes:

  1. Its products compete on primarily on price, but it is not the low-price competitor.
  2. Its products are the same as another company's products: corn is corn.  Tell me the the real difference between a Dell notebook and a Lenovo.  A beer is a beer.  But what is a Budweiser?
  3. It has no brand identification.  A Coke is a Coke but a cola is a commodity.  And the difference between a Lenovo and a Dell is brand identification.  And Bud is an honored brand with a loyal following.  Other beers just won't do.
  4. It can't raise its prices with inflation or increasing costs.  Corn today costs what it did in 1948.  But Wrigley's Gum prices have kept up with inflation.

Bottom line, if you don't care who the manufacturer of the product is, it's a commodity. 

So power companies are commodities and the investment is all about the shortage of that commodity and the ability of that company to ride the shortage.

Airlines have turned themselves from brands like Pan Am into commodities like Delta.  Today an airline seat is an airline seat.  This has been done by the lethal collaboration of airline execs and airline unions and an only quasi-open market. 

Same with car companies.  It's horrible to say that the unions and management are
getting what they deserved, especially when the managers that did the damage are camped on millions in retirement while the workers who collaborated are looking to get their pensions whacked. 

But they are both complicit — they raped the equity and the brands by good-ole-boy fraternity management that was characterized by coming up with the good idea too little and too late for lack of both creativity and courage — and by labor that was out for as much of the profit of that business as it could get its hands on, regardless of the future of the business. 

And so, today, while you can't regard GM as a commodity, it certainly isn't a brand I'd be proud to own.  The only thing they make that I like is their line of trucks and SUVs.  And with the unions and the same bs bunch of buys managing the business, you have to be Kirk K to want a piece of this thing.

Honda on the other hand does not have the same problems, so I'd consider it if I liked the company and if they didn't have to deal with unions… which they do.  Bottom line, strong unions make for bad investments most of the time, simply because they have the power to grab the surplus capital — and that ain't a good thing for an investor.

So while I sort of agree with Hagstom's list, I wouldn't call everything on it a commodity… just bad investments.

Now go play.

Phil

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Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.