With China and emerging markets slowing down and fragile recoveries in the US and Europe, investors will struggle to find companies that can reliably increase earnings this year, says global asset manager AllianceBernstein (AB).
However, Mark Phelps, AB’s Chief Investment Officer – Concentrated Global Growth, says that pricing power can help investors identify companies that are capable of delivering sustainable growth in this environment.
“In a low growth world, pricing power can unlock higher profits. But with inflation stuck at very low levels – 0.5 per cent in the US and about 1.0 per cent in the euro area – it’s not easy for companies to raise prices, says Phelps.
Pricing power is about more than the simple ability to raise prices, however. According to Phelps, in order to find companies with pricing power, investors need to understand the three keys to pricing power: innovation, competition and cost dynamics.
“Innovation is a great enabler of higher prices,” says Phelps. “Technology companies that create products or services that never existed before can command higher prices. The same can be said for drug makers who develop new treatments.”
Pricing power is often a function of the competitive environment. “Take the supermarket industry in the UK, where discount supermarkets such as Aldi and Lidl have cut prices so low that they are creating big problems for giant rivals like Tesco and Sainsbury.
“The premium brand supermarkets today can’t use their usual tactic of regularly raising prices slightly in a world without meaningful inflation. This same logic can be applied to other industries where low-cost providers have taken market share, from airlines to finance.”
In a low-inflation world, cost dynamics are crucial. “Consider a company like Ecolab, which makes cleaning chemicals derived from oil-based products. With oil prices at extreme lows, Ecolab’s input prices have dropped dramatically. So even without raising prices, profitability can increase.”
Pricing power is always an important component in the fundamental analysis of a company’s business model and earnings prospects.
“Today, with big challenges facing top-line growth across an array of industries, we believe that it is essential to understand pricing power to develop high conviction in specific stocks,” says Phelps.