Pricing power can help companies fight inflation
At Madison we believe strongly in owning high-quality, competitively advantaged businesses that can generate strong risk-adjusted returns over time and through all business cycles. One of the reasons we think this focus on high-quality business models is critical is due to the numerous headlines stating inflation could be less “transitory” and more “sticky” than we have seen in the past 40 years. A major factor for equity investors to ascertain in an inflationary environment is a firm’s ability to exhibit “pricing power,” or its capacity to easily pass on higher costs to consumers given their product’s desirability with consumers. The more competitively advantaged the firm is, the easier it is for them to raise prices. Diana Wagner, a Portfolio Manager for Capital Group, discusses her thoughts on why pricing power may be a vital competitive advantage for businesses in 2022.
Pricing power can help companies fight inflation:
By: Diana Wagner, Portfolio Manager, Capital Group
“Remember in 2011 when Netflix raised prices by dividing its streaming subscriptions from its DVD service? The announcement sparked an uproar that forced the company to issue an apology and hammered the stock price.
Today the world is in a very different place — and so is Netflix: The company is now a dominant streaming service and a megahit-making machine with more than 213 million subscribers worldwide. Its latest breakout, “Squid Game” — a Korean drama about children’s games played with deadly consequences — captivated some 142 million households, making it the most viewed show in Netflix history.
This rising popularity has empowered the company to boost its prices. It has increased subscription rates in the U.S. four times since 2014, a period of robust subscriber growth globally. This is an example of pricing power, the ability to increase prices without losing customers.
Pricing power can be an antidote for inflation
Pricing power, always a positive for companies that can sustain it, may be a crucial competitive advantage in the year ahead. Inflation has surfaced in the economy, and there are signs that it could linger in the coming months. The annual inflation rate in the U.S., as measured by the consumer price index, rose to 5.4% in September, its highest level in 13 years. Rising costs can erode a company’s profit margins and, ultimately, investor returns. But companies with clear, sustainable pricing power can protect their profit margins by passing those costs along to customers.
In some industries, there is greater potential for pricing power
With growth slowing and inflation pressures building, as an equity portfolio manager for Washington Mutual Investors FundSM, I think it is essential to understand how companies with pricing power can offset inflation.
I’m not ready to believe we are headed into a period of sustained inflation. But I do believe rising costs are likely to linger in the coming months, making it the biggest risk investors will face in 2022.
That’s why I am so focused on uncovering companies with pricing power.
I recently asked the investment analyst team that supports Washington Mutual Investors Fund to find examples of pricing power in the industries they cover. They came up with dozens of ideas, ranging from companies in the defense industry to technology and the consumer staples sector.
With slowing growth, rising inflation and other uncertainties on the horizon, 2022 may seem a daunting environment for investors. But I’m optimistic that an active portfolio of select companies with strong pricing power can help investors thrive in the years ahead.”
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