Pricing power is one of the most important indicators of a strong and high quality business as it helps companies to protect or grow their profit margins. The ability to put up prices without weakening demand is a trait that many companies would like and very few possess.

Companies that can’t push up selling prices may find it hard to generate additional value for shareholders, particularly if their margins are being squeezed by higher input costs.

So why is this relevant now? Concerns about economic growth in many parts of the world may have led some investors to deduce that pricing power is hard to achieve at present. Various consumer goods companies over the past week have demonstrated it is still possible to lift prices.

Nestle and Unilever (ULVR) both reported a pick-up in sales after charging higher prices for their products. This is an important shift in fortunes as earlier this year consumer goods companies in general were relying on higher volumes to drive revenue growth.

The extent to which it matters to investors was laid clear by the market reaction to Procter & Gamble’s latest update. It told analysts and investors on a results conference call that it too was about to raise prices on several products around the world, triggering a 7% hike in its share price.

This is a huge breakthrough given fragile market conditions in various parts of the world. However, it is worth noting that Procter & Gamble won’t be able to push through higher prices across the board as certain categories such as grooming remain too competitive to risk increasing the price ticket.

PRICING POWER UNDERPINS QUALITY EARNINGS

Pricing power can represent a higher quality of earnings, which in turn can drive share price outperformance over time. It can be linked to brand strength and/or limited competition. For example, Apple initially had considerable pricing power with its iPhone although this waned as the smartphone industry market grew and countless alternative products hit the market.

Some of the big consumer goods companies benefit from having rich relationships with retailers, meaning their products take up lots of shelf space which acts as a barrier to weaker rivals, plus it positions their brands at the forefront of shoppers as they browse for goods.

Another topical example of pricing power is TV and film streaming service Netflix which is conducting trials in Europe to gauge customer response to different price packages. While it is seen as a must-have service by millions of people, I don’t believe Netflix has been around long enough to really make a judgement on its pricing power capability.

The idea of searching for companies with pricing power has been central to many investment strategies, most as part of a wider process although there are few ETFs and funds dedicated to this concept including US-listed Principal Price Setters Index ETF.

While pricing power should be considered alongside other factors such as valuation, it is fair to say that a company with sustainable pricing power is highly likely to be a great long-term investment. (DC)

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