Week 163 - How To Bet On Commodity-related Stocks While The Children Are Watching

Situation: We all need to know how to drink responsibly, drive responsibly, eat responsibly, and flirt responsibly. But how, exactly, are we to gamble responsibly? If you’re a regular follower of our website, I’m sure you’ve gambled on something at some time in your life. This is behavior that is what John Maynard Keynes blamed on “animal spirits.” Here at ITR, we try to take the gambling out of investing because we think you’ll get a more comfortable retirement that way. 

Now we need a way to gauge whether or not we’re gambling on “hot” stocks. I travel a lot, researching the blog and trying to learn how people like to invest. I hear amazing statements. While riding up a ski lift last winter in Vail, I heard a real estate developer say "People aren't interested in saving for retirement. Look at the choices they make!" He knew what interests most people the most, i.e., moving to a house that better reflects the status they want to project, and he’d made a lot of money feeding that interest. 

More and more though, I’m struck by how carefully children monitor adult behavior. They quickly come to understand how a family gets to be “house poor” by living beyond both its means and its needs. And they’re less sure than ever about what lessons to take away from observing adults. A child will naturally look for someone to model her behavior on, anyone really, whose behavior suggests that he or she has character--a sense of responsibility and respect toward people in their home, their neighborhood, and the larger community. The word I hear them use is “dishonest”, to sum up places and people that don’t do that. 

This week’s blog is about learning to invest in traditionally risky stocks without gambling. We recommend doing this by looking at companies in the riskiest industries. i.e., energy and basic materials. Both are “commodity-related” industries and their stock values show the greatest variance. 5-yr Beta values are typically 50% higher than the S&P 500 Index, and losses during the Lehman Panic were typically 20% greater. A few simple rules will get us there, starting with all 68 such companies in the Barron’s 500 List that have long-term total return records:

        1) Exclude companies with S&P bond ratings of BBB- or lower, since S&P typically uses the BBB rating to designate a company that is doing OK at the moment but gambling with its life. Bear Stearns, for example, had its debt downgraded from “A” to “BBB” on March 13, 2008 just three day before J.P. Morgan Chase purchased it for $2.00/Share with assistance and encouragement from the Federal Reserve.

        2) Exclude companies that had lower scores for 2013 vs. 2012 on the Barron’s 500 List (see Week 158), unless scores for both years were in the top 300.

        3) Assign the “Not Gambling” label to companies that have S&P bond ratings of A- or better, and BBB+ if the company is a Dividend Achiever.

4) Assign the “Gambling” label to the remaining companies.

5) As a final “belt and suspenders” action, move any companies out of the “Not Gambling” category that lost more than the 28% that VBINX lost during the 18-month Lehman Panic period. 

This week’s Table shows the results. There are 7 “Not Gambling” and 19 “Gambling” stocks to choose from. For comparison, the BENCHMARKS section includes PRNEX (T Rowe Price New Era Fund), which is the lowest-cost mutual fund dedicated to the energy and basic materials industries. As always, red highlights denote underperformance relative to our key benchmark, The Vanguard Balanced Index Fund (VBINX). 

Bottom Line: You don’t have to gamble to own commodity-related stocks. Just do the above screen then take more time than usual to research the “story” supporting each company’s stock price. Pick a stock, start a DRIP (e.g. at computershare), and automatically invest $25-200/mo in the company of your choice. When the price swoons, keep investing as long as the “story” holds.

Risk Rating: 7

Full Disclosure: I own shares of MON.

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