Prizing Pricing Power

Earnings season kicks off next week, with the big banks reporting first-quarter results. The coming deluge of earnings reports -- and CEOs’ earnings conference call comments on the business outlook -- will be an important lens for investors to determine which companies will be able to keep growing despite rampant inflation and an economic slowdown in the United States and throughout the world.

Could you identify those likely companies today?

My Review & Preview colleague Nicholas Jasinski conducted an informative exercise to find those companies with sufficient “pricing power” to maintain -- or increase – their profit margins even in a treacherous business environment.

Generally speaking, there are four main paths to building pricing power:

·        A company sells a product that is essential or limited in supply, meaning that customers have few choices beyond paying the higher price.

·        A company has few direct competitors.

·        A company innovates and can raise prices on improved products and services.

·        A company becomes more efficient, holding down its costs.

Nick screened the S&P 500 for companies that “grew their gross margin (revenue minus the cost of goods sold, divided by revenue) from 2020 to 2021 as the economy rebounded, but also had rising, positive gross margins in at least the three years before the Covid-19 pandemic.”

He found 27 companies, ranging in size from software midcap PTC to software behemoth Microsoft and in sectors like healthcare, industrials, and consumer discretionary, as well as technology.

Tech companies, including Nvidia and Broadcom, and healthcare companies like Merck focus on innovating and differentiating themselves. Fast-food chains like McDonald’s and Yum! Brands have been able to raise prices when labor and food costs rise. And Cintas, known for its uniform rentals, is trying to bring down costs through automation.

Eric Schoenstein, chief investment officer of Jensen Investment Management, which manages about $14.5 billion, tells Nick:

There are so many cost pressures out there these days.  We’re trying to find businesses that have resilience through those difficult circumstances. The ones that have already been tested and come out the other side should have the ability to do it again.

Read the rest of Nick’s report here.