Identifying firms with pricing power is crucial for investors. A gap between input and output price inflation is typically interpreted as a sign that firms are struggling to raise prices and that margins are being squeezed. But the prices of manufactured goods and services also rose at the fastest pace since records began in 2009. On November 2nd JPMorgan Chase’s global purchasing-managers index, a measure of manufacturing activity, showed that input prices in the sector increased in October at the highest rate in more than 13 years. If costs spiral out of control, the power to raise prices will become ever more important. In the second quarter, such mentions were up by 52% year on year. “In fact, what we have seen is another spectacular quarter on behalf of corporations so far in spite of input cost pressures.” According to Savita Subramanian and Ohsung Kwon of Bank of America mentions of “price” or “pricing” in American earnings calls-a proxy measure for pricing power-increased by 79% in the third quarter from a year earlier. “This earnings season there was a lot of angst on the part of investors that higher input costs would erode margins,” says Patrick Palfrey of Credit Suisse, a bank. Of the S&P 500 companies that have reported third-quarter results, over three-quarters beat projections, according to Bank of America Merrill Lynch. “We are a luxury company, so we do have pricing power,” bragged Tracey Travis, CFO of Estée Lauder, a cosmetics firm, on November 2nd. Companies such as Starbucks, Levi Strauss and GlaxoSmithKline make similar claims.
“We believe we’ve got pricing power really better than almost anybody if not everybody in the industry,” boasted John Hartung, CFO of Chipotle, a restaurant chain, in October. “We can reprice our product every second of every day,” Christopher Nassetta, boss of Hilton Worldwide, a hotel operator, told investors last month. Today, firms are eager to flaunt their price-setting clout. Those with pricing power can push costs onto customers, keeping margins steady.
When hit with an unexpected expense, firms without pricing power are forced to cut costs, boost productivity or simply absorb the costs through lower profit margins. Warren Buffett has described it as “the single most important decision in evaluating a business”. “Pricing power”, the ability to pass costs to customers without harming sales, has long been prized by investors.
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