La investment in stocks is suffering from the effects of inflation. It is now more important than ever to find companies that can defend their results. And this is where companies with strong “pricing power” (the ability to pass on costs without losing customers) come into play. Let's look at the characteristics that give a company pricing power, as well as which companies stand out within each of them.
Investing in stocks of a concentrated industry
When companies want to pass on price increases, they tend to measure what the competition is willing to do. This varies from industry to industry. But those that are more mature and “concentrated,” that is, where fewer companies represent a larger share of the market, tend to be more disciplined in their pricing policies. This is because investing in stocks in such industries does not have to worry as much about its competitors suffering persistent losses in order to gain market share. In other words, they are better able to raise their prices without losing customers. We can check the concentration of an industry with this tool, which gives us a good perspective on how they compare to each other. For example, we can see that the four largest companies in the personal and home care sector ( Procter & Gamble, Kimberly-Clark, Colgate-Palmolivey Estée Lauder ) account for more than 70% of the market share.
Concentration of the personal and home care sector. Source: MSCI
Meanwhile, the top four in the materials sector (on the right) only represent about 30% of the industry. That gives the former much more pricing power.
Concentration of the materials sector. Source: MSCI
Investment in shares with brand presence ✨
When there are too many options, consumers tend to gravitate toward the familiar. They choose to invest in shares of brands such as Coca-Cola (KO), McDonalds (MCD) and Starbucks (SBUX) that have international brand power and consistent quality around the world. That means they've built a reputation that ensures consumers will stick with them even if they raise their prices.
LVMH It is the same, but it has another additional advantage. Not only does it carry brands associated with quality like Christian Dior and Tag Heuer, but it also caters to wealthier customers who are less price sensitive. That means luxury brands have more pricing power than your average brand.
Investing in stocks with a defined strategy️
It is not enough to be able to raise prices without losing sales: it is also important to be able to raise them quickly. This is particularly difficult for retailers, restaurant chains and similar services, all of which have to spend time and money changing price tags, signage and menus to reflect the new prices. But it's easy for companies like L'Oréal (Gold Shiseido (4911) who make a large proportion of their sales online, as they can adjust prices in a matter of clicks without additional administrative costs.
Movements of the last year of l'Oreal and Shiseido. Source: Bloomberg
We also have to take into account that technological advances have complicated things. Take the consumer staples sector, which has always been thought to have relatively strong pricing power. But this power has been noticeably eroded as e-commerce has made it easier for small brands to bypass traditional retailers. Which clearly leads us to…
Investment in shares of direct distribution with the client
The more intermediaries there are between a company's product and its customers, the less profit it will make for itself. That is obvious in the battle of Unilever (ULVR) with the supermarket chain Tesco (TSCO) in the UK. The conglomerate has a strong brand and healthy market share, but its ability to raise prices is still ultimately limited by the outlet that sells its products.
Investing in shares with long-term cost-indexed contracts
Long-term contracts are a good way to ensure a company's profit growth and margins are stable and predictable, especially in a recessionary and inflationary environment. Even better if these contracts are aligned with cost indices, such as those that track wages or gasoline prices in the US. That way, the customer is forced to pay more as those costs increase. without having to go back to square one and renegotiate new prices. Industrial gas companies such as Linde (LIN), Air Products (APD) and Liquid air (AI) typically have cost-indexed contracts with their customers that last between 10 and 15 years, helping to guarantee them a baseline level of demand while ensuring that any increases in costs are passed directly on to their customers.
Investing in stocks with income streams linked to inflation⚖️
Investing in payment processing stocks like View (NYSE:V) and Mastercard (NYSE:MA) have an interesting business model that benefits their pricing power in an inflationary environment.
Movements of the last year of Visa and Mastercard. Source: Bloomberg
Why do Visa or Mastercard benefit from inflation? Let's take an example: if the price of a pack of gum goes from €1 to €1.50, Visa and Mastercard will benefit proportionally from the price increase. That's because they charge financial institutions that issue Visa or Mastercard-branded cards a fee based on the nominal volume of activity. So, most of both companies' income streams should grow in line with inflation.
Investing in stocks with perceived or real value
When investing in stocks in the chemicals and fragrances sector, the real value of their products is often higher than the perceived value. But that gives them their own freedom to raise prices as they see fit. Symrise (SY1), Givaudan (GIVN) and Croda (CRDA), for example, only provide small quantities to consumer companies, but are arguably the ones that make or break the final product. So while they only represent about 4% of your customers' total cost (the perceived ), changing them would be costly and potentially damaging to the brand (the part ).
We've already mentioned that luxury buyers pay as much for a brand as they do for anything else. That means that the image and identity of that brand are more important than the basic function of the product. In other words, the part A luxury handbag may store a few accessories, but it provides much more in perceived . That gives luxury companies much more room to raise their prices.
Companies with the ability to reduce costs
Companies that remain strong are historically good stock investments, generating great returns relative to the money they spend. But it also means they have less fat to trim in an inflationary environment than their less efficient peers. So, if all else fails and a company is struggling to pass on cost increases, you'll want to choose one that can reduce expenses to keep its profit margin stable. We can find these companies by comparing their costs as a percentage of sales with others in the same industry. A higher expense base can reveal structural inefficiencies for a company, but it also highlights where there is fat to trim. We just have to make sure that companies have fixed so they have more flexibility to reduce expenses.