Inflation in the UK came in at 5.4 per cent, its highest level in 30 years, in the most recent ONS figures – hurting savers, threatening company margins and unsettling investors.
Some companies however, are in a better position to pass these costs on to their consumers, which will prove to be a competitive advantage over the next year as inflation lingers.
Investors keen to shield their portfolios from inflationary pressures should look out for companies with this kind of pricing power, a key passive investment factor that star fund manager Terry Smith, of Fundsmith, referred to in his recent letter to shareholders.
But what does pricing power mean and how can investors spot firms with it and evaluate their stocks?
The price is right: Companies with higher pricing power are in a better position to shield themselves from inflationary pressures
What is pricing power and why is it so important?
As inflation climbs, online mining it can dent companies’ profit margins and thus investor returns.That’s because it isn’t just consumers that suffer from inflation, so too do companies, as they face higher costs that will eat into profits, on everything from materials, to transport and energy bills.
Ideally, companies would want to pass the cost on to customers, online mining by raising the price of their products or services, but they risk seeing demand fall by doing that.
So, what they need is a competitive edge that means that even if they do charge more, their customers – be they consumers or other businesses – will pay up.If they can do that, they have pricing power.
Companies with high, and perhaps more importantly, sustainable pricing power will be able to protect their margins by passing the cost onto customers with little pushback. They are therefore in a better position to navigate a high inflationary environment.
Pricing power has long been prized by investors, not least veteran investor Warren Buffet.He has referred to his moat analogy for decades – a defensive barrier that means a company is successful because it has a product or service that maintains a competitive advantage over rivals.
He has also described pricing power as ‘the single most important decision in evaluating a business’.
In his recent shareholder letter, Fundsmith’s Terry Smith said one of the reasons poor online mining returns can persist is because companies with many competitors lack ‘control over pricing’.