Dealing with inflation

January 21st, 2013

Commodity companies

Warren Buffett does not like to invest in what he calls commodity companies - companies whose product does not differ from that of competitors in any significant way.

A company like this can be vulnerable to the actions of competitors and have limited power to raise prices to retain their profit position in the light of inflation.

What Warren Buffett says about commodity companies

Warren Buffett said this in 1982:

[Where] costs and prices are determined by full-bore competition, there is more than ample capacity, and the buyer cares little about whose product or distribution services he uses, industry economics are almost certain to be unexciting. They may well be disastrous.

Non-commodity companies

Warren Buffett prefers to invest in non-commodity companies - companies whose products or services are unique or special in some way.

Here customers either need the product, or there is no real competitor, or the reputation of the product is such that people will keep buying it. Suppliers and distributors have no choice but to stock the product or people will go elsewhere.

Generally, but not always, either the product will be a brand name (eg Coke, Gillette), the company will be a brand name (H & R Block) or the company will be in a monopoly situation or monopolistic cartel.

What Warren Buffett says about non-commodity companies

Warren Buffett illustrated this difference in 1982:

[There is the] constant struggle of every vendor to establish special qualities of product or services. This works with candy bars (customers buy by brand name, not by asking for a “two-ounce candy bar”) but doesn’t work with sugar (how often do you hear, “I’ll have a cup of coffee with cream and C & H sugar, please”).

Berkshire Hathaway holdings

Stocks held by Berkshire Hathaway in 2002, as stated by Buffett in his letter to stockholders include:

  • The Coca Cola Company
  • American Express
  • The Gillette Company
  • H and R Block Inc
  • Moody’s Corporation
  • The Washington Post Company
  • Wells Fargo and Company

These are all companies with a unique or special product, or with a company brand name, or in a market domination position. They or their products have a loyalty (voluntary or otherwise) that means customers want or must come back.

Another desirable quality in non-commodity companies is repeat business. Customers drink their Coke, wear out their razor blades, or finish reading their Washington Post, and then, eventually have to replace it.

What Warren Buffett says about good businesses

Good businesses with that ‘protective moat’ that Warren Buffett likes have the ability to cope with inflation by raising prices. As he said in 1993:

The might of their brand names, the attributes of their products and the strength of their distribution systems gives them an enormous competitive advantage, setting up a protective moat around their economic activities. The average company, in contrast, does battle daily without any means of protection.

Posted by Julian Livy on January 21st, 2013 | Posted in How Buffett invests |