The tough economic environment of slowing growth and rising costs is setting up to benefit companies with one enviable attribute: pricing power.
The ability to “transfer higher input costs to consumers and maintain profitability relative to their competitors,” is “an alpha factor” in a company amid a global growth slowdown and lower earnings guidance, according to Evercore ISI’s analyst Dennis DeBusschere.
“We are concerned increasing input costs given productivity remains low, labor market demand high, wages are trending higher, and core inflation has been rising since late 2017. Firms with pricing power are likely to outperform their peers as global growth slows and earnings guidance remains negative,” DeBusschere said in a note Wednesday.
U.S. companies have come under pressure as the borrowing costs keep rising and the tariffs resulted from the ongoing trade battles between the U.S. and China added to the burden. In an era of higher costs and increasing competition, the ability to increase prices without losing profitability becomes crucial.
Take Netflix. The media-screaming company hiked its subscription prices by a range of 13 to 18 percent on Jan. 15, sending its stock up 6.5 percent in intraday trading. The surge in the stock reinforces the importance of pricing power as Netflix managed to pass on the extra cost for its investment in original shows to its subscribers. The company reported better-than-expected earnings per share last week and its shares are up nearly 20 percent this month.
Evercore built an index consisting of 40 stocks that its analysts believe have the most pricing power. The index, with 32 percent weight in consumer discretionary and 15 percent in information technology, has outperformed a randomly generated portfolio by 19 percent since the start of 2018, DeBusschere said.
Bank of America and Lululemon are among the companies in Evercore’s index. Bank of America reported better-than-expected profit and revenue for the fourth quarter last week, driven by a strong performance from its consumer-banking business and lower taxes. Lululemon raised its fourth-quarter outlook last week, saying it benefited from the best holiday season in six years.
The analysts picked Bank of America for the index because of its ability to “absorb increased deposit costs and pressured margins from rising short-term rates,” according to Evercore.
To be sure, pricing power is only one of many factors dictating a stock’s direction, and it only plays a leading role when overall corporate margin pressure is high.