"I work sunup to sundown... Ain't too proud to sweep the floors."
—from "Cost of Livin’," as performed by Ronnie Dunn
Last week we talked about the combination of peace, prosperity, globalization and technology that’s driven down inflation consistently over the last half century. It may not seem like it, but on average, most goods are getting cheaper over time. Not everything is on sale, though. Prices for services, which represent a large and growing chunk of the economy, have been growing steadily for years.
So how to apply that knowledge to investing?
One strategy is to consider avoiding commodity-based businesses, which are “price takers," and invest instead in companies with built-in pricing power, or "price makers." Pricing power is a company's ability to raise prices consistently without having those profits siphoned off by rising costs.
Some companies have pricing power because a consumer doesn’t think there’s a worthy substitute for that brand. Some companies have pricing power because there really aren’t any substitutes. Some companies build pricing power into their contracts so that they get paid a little more every year. Companies that have any form of pricing power are golden in a deflationary world.
For example, high-end coffee chains buy coffee beans, roast them and then sell not just a latte but an experience that consumers are willing to pay up for. Coffee bean prices are close to decade lows, yet skinny vanilla lattes and Frappuccinos are dearer than ever. The input, coffee, has gotten cheaper over the last decade; yet the output, drinking that coffee in a stylish storefront or conveniently picking it up on your way to work, keeps getting more expensive. The company captures the difference.
Another example is a cable company that provides broadband internet. Has your internet bill ever gone down? Is it likely to? But in the face of price increases, most of us will sigh, resign ourselves to the fact that we need internet access to work and live, and pay the higher monthly fee. That’s another form of pricing power.
Companies involved in the production of oil and gas are the definition of price takers. They literally sell their end product at a price determined by the market, not the company. When oil is $120 a barrel, that's fine. At $50 a barrel, not so much. No pricing power.
Instead, why not own oil and gas pipeline companies? Some publicly traded pipeline operators have almost no exposure whatsoever to the price of oil or gas and have inflation “escalators” written into their long term service contracts. As long as their customers are using the pipes (which is likely), these pipeline operators get paid a little more every year regardless of the direction of energy prices.
Margaret R. McDowell, ChFC®, AIF®, author of the syndicated economic column “Arbor Outlook,” is the founder of Arbor Wealth Management, LLC, (850.608.6121 – www.arborwealth.net), a “fee-only” registered investment advisory firm located near Sandestin.