The "Monopoly Man" Had It Right: Competition Stinks!

Adem is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Whether you preferred the thimble, the shoe, or the top hat, Monopoly was a childhood game that many of us enjoyed. And while the "get out of jail free" card was fun, the best part of the game was owning multiple properties, building hotels and houses, and jacking up rents. 

We can reclaim some of that childhood nostalgia by investing in "monopoly" stocks--companies that have relatively few investors. Monopoly stocks work well in uncertain markets, like this one for two reasons:

1. Companies that have relatively few competitors can increase prices. Pricing power is a way to fight against inflation and increase earnings, even without big increases in revenue. 

2. Monopoly stocks avoid the costs (R&D, advertising, etc.) that come with having to fight competition. Lower cost structures are particularly helpful in down economies, when cash is tight.

In short, they work. Here's a few that should work today. 

Take the rails past "Go"

The rails operate as an oligopoly, with very few competitors. While an oligopoly isn't a monopoly, it's the next best thing.  If you were to buy just three stocks: Union Pacific (NYSE: UNP), CSX (NYSE: CSX), and Norfolk Southern (NYSE: NSC), you'd cover most of the country in rail.

The wonderful news (for investors), is that once the rail is laid few (if any) competitors interfere. CSX, for instance, runs its northeastern network like a monopoly as do Norfolk and Union Pacific in their markets. This allows rails to participate in price collusion to a degree, where they mercilessly increase prices on consumers who have no better alternative. As long as a customer has an alternative, like trucking, it's legit. And as gas prices get higher, the viable options outside of rail are going to become fewer and far between. Customers may complain about prices, but they know in the end that rail is still three times as fuel efficient as highway travel--and growing! So, while they may not like price increases, the customers are still getting a tremendous value.

These businesses have customers in many sectors: like agriculture, coal, and autos. Coal's recent woes appear to be short-term in nature, exports are still expected to rise. Coal has also kept CSX and Norfolk relatively "cheaper," currently, than Union Pacific.

Check out the valuations on these three businesses, as well as their coal-related revenues.

Company P/E P/S % of revenue related to coal
CSX 13.3 2.07 24.6%
Norfolk Southern 13.5 2.12 22.1%
Union Pacific 17.3 3.15 13.8%

My opinion is that the worries of coal are overblown. Recent earnings from coal companies have pointed to a potential bottom in prices, and long-term exports are expected to rise. CSX and Norfolk trade at better values due to overblown worries, creating even more value than in Union Pacific.

Therefore, I'd buy a few shares of CSX and Norfolk today with the long-term goal of adding Union Pacific on a pull-back. Either way, if you're a long-term investor, I feel that you can't lose with the rails.

Monopoly: better with hot sauce

I know what your thinking. Microsoft in the 90's, now that was a monopoly. If only they'd offered a burrito with that software, the glory days would've lasted forever!

Ok, maybe you weren't, but Yum! Brands "Taco Bell(NYSE: YUM) and Chipotle (NYSE: CMG) offer burrito's with bank.  The funny thing is, these two companies appear to be the anti-thesis of each other. But isn't that the point?

You want stocks that offer something different, both of these companies do just that. Do you know of another burrito joint that is so entrenched in the healthy eating and living movement? Do you know of another major fast food chain that offers a taco with a Dorito as a shell? The Doritos locos taco, which may sound funny to some, is offering Yum! shareholders a safety net as the company leans on Taco Bell more. Chipotle and Taco Bell both offer something unique to the marketplace, which allows them to outperform without stepping on each others toes.

It also leads to industry leading return on equity for Yum! Brands (80%) and Chipotle (24%). Taco Bell and Chipotle don't have any competitors that offer what they do on their scale, the margin increases should continue.

Recent worries of food quality in China for Yum! and KFC have created a slight pause in the stocks rise. The worries, and related bird flu scare, are expected to be short-term in nature. Therefore, Yum! is trading at a slightly lower multiple (21) than Chipotle (37), which just reported another stellar quarter. Take a sample of Yum! today, and put Chipotle on your menu (puns intended) for the next time investor worry sets in. With same store sales slowing (slightly) and a plethora of "big name" investors shorting the stock; Chipotle shouldn't make you wait too long for a buying opportunity. 

 

I'm not the Monopoly Man...but I love Monopoly, man

With the market at all-time highs, and potentially overvalued, investors are unsure of what to do. Everyone's looking for answers. But the funny thing is, great stocks work in every market. 

The companies that win in all markets, have relatively few competitors. They're the best of breed. They'll outperform in good times and bad. They're what you need when you don't know what will happen next.

It's funny. We talk about the "right time" to buy and, as I mentioned, all of these stocks have had headline risks. All of the rails have sold off at some point--in varying degrees--due to coal. Chipotle was shorted by David Einhorn. Yum! has quality concerns in China.

But there's also something else they all have in common.

CSX and Yum! have each grown earnings at a compounded annual rate of 15% over the past five years. Union Pacific at a whopping 19%. Chipotle, has been on a different planet--33%.

They all have stellar returns on capital. The point is, amidst all the worries and headline risks, these companies have maintained returns on capital due to having relatively few competitors. When a company doesn't have to eat into margins, earnings rise like clockwork; until new competitors rise, even with scary headlines, earnings will march upward.

After-all if a company is growing rapidly and doesn't have a competitor to stop it, what will?


Adem Tahiri has no position in any stocks mentioned. The Motley Fool recommends Chipotle Mexican Grill. The Motley Fool owns shares of Chipotle Mexican Grill. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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