Inflation Is Here – Warren Buffett Says These Are the Companies To Target on the Stock Market
"Pricing Power" is the criterion that you should absolutely rely on.
Jerome Powell has been denying the obvious for several months, but inflation is here. Inflation has been above 5% for several months in America, and all the figures indicate that the situation is set to last for some time. After talking about transitory inflation, Jerome Powell is now talking about transitory conditions leading to this high inflation.
A way out when inflation is no more transitory than it is under the Fed's control. The Fed has begun its tapering, but in a very moderate way with a planned reduction of $15 billion per month in its asset purchase program.
The Fed will still buy $105 billion of financial assets in December 2021, while leaving itself the possibility to slow down this reduction and even stop depending on economic conditions. In short, the Fed does not want to make any real decision and is playing for time.
Pricing power is an essential advantage that only some companies have
Meanwhile, businesses are being hit hard by rising raw material costs, higher transportation costs, and now higher wages in a tight labor market. These increases will affect the margins and profits of companies.
Except for companies that have an advantage over others. This advantage is called “pricing power”. It is the power to pass on the cost increase to their customers.
Companies that have this “pricing power” with them have become the most sought-after nuggets for investors in the stock market. These companies have products that are in such demand that a price increase has no impact on their sales.
When you read this, you're thinking of Apple, which can raise the price of its devices over and over again without the brand's fans turning away. But beyond Apple, many other companies have this pricing power. According to a recent study by the Swiss bank UBS, these companies are in the following sectors:
Consumer staples
Communication services
IT services
Healthcare
Real estate
On the other hand, those that benefit the least from this “pricing power” are generally located in the following sectors:
Industrial companies
Utilities. These are companies that provide us with water, electricity, gas, ...
The financial sector
The energy sector
In a period of high inflation, Warren Buffett uses “pricing power” as the most important decision criterion
Warren Buffett frequently repeats that the “pricing power” of a company is a determining element. He even said one day this:
“Pricing power is the single most important criterion in evaluating a business.”
So you won't be surprised to discover that Apple represented 40% of Berkshire Hathaway's portfolio at the end of June 2021:
You read that right. Of Berkshire Hathaway's $330 billion equity position, Apple was worth over $135 billion at the time. These are the types of companies you need to target in a high-inflation environment like the one we'll be in for the next few months.
Some companies currently seem to be exceptions to this rule, but this will not last forever
Still, there can be exceptions to this rule. When reading the latest quarterly results of the companies that have just been published, we see that even those that theoretically have the least pricing power have still been able to pass on the increased costs to their customers.
It seems that this COVID-19 pandemic has completely changed the traditional rules.
For example, McDonald's was able to raise its prices without impacting demand. Other fast-food chains did the same, but also Starbucks. This has been observed for textile brands such as Levis, hotel chains such as Hilton, and of course the luxury sector which is benefiting greatly from the Cantillon Effect which has boosted the wealth of American billionaires by more than $2.1T over the last eighteen months.
What remains a surprise so far is that this crisis has not caused a drop in purchasing power but, on the contrary, an explosion in savings and corporate liquidity. In this phase of post-crisis liberation, which is still going on, consumers have become as if insensitive to price increases.
Almost all companies have been able to benefit from pricing power in this particular phase.
Final Thoughts
Unfortunately, all good things must come to an end. When the recovery is over, when the euphoria of consumption has subsided, but the inflation is still there, it will be the companies that traditionally have pricing power that will once again take over.
Thus, Warren Buffett's strategy remains more relevant than ever for the weeks and months to come. And it's no wonder that many analysts now imagine that Apple could reach 3,000 billion dollars of the market in the future.