Companies’ costs are rising too quickly. That squeezes profit margins, which investors can avoid by picking companies with the strongest pricing power.
With the aid of Wolf Research, we set out to find companies that managed to increase their gross margins even as the pandemic withered big chunks of the economy. Tapestry (ticker: TPR), Coca-Cola (KO), Philip Morris International (PM), Altria Group (MO) and Nvidia (NVDA) are our top five. More on them later.
Many companies are having trouble fully passing along higher costs to customers. The producer-price index for goods, which measures the cost of companies to acquire materials, has risen 13%, about twice the increase in consumer prices. It’s the biggest percentage-point spread between the two indexes since the 1970s.
To be sure, the aggregate operating margin on the S&P 500 rose from the second quarter to the third quarter. But that is a function of extraordinary government stimulus and pent-up demand from consumers who were unable to spend freely during the early days of the pandemic. Margins would be much better if not for higher costs.
While the supply situation is improving, some indicators such as briskly rising producer prices in China point to further pain. “Our forward indicators strongly suggest that producer prices are going to keep rising,” wrote Chris Senyek, chief investment strategist at Wolfe Research.
Enter pricing power stocks. These companies are usually the most competitive in their industries and can therefore raise prices most easily when necessary.
Wolfe Research screened for those stocks by first looking for S&P 500 companies with gross margins in the top 20% of their industries over the past three years. A company with a higher gross margin than its competitors is often growing profitability by raising prices because its products are superior. Of those companies, Wolfe included only those that grew gross margins in the second quarter over the 2019—or pre pandemic—second quarter, indicating that cost pressures didn’t get in the way of improving profitability.
Here are 5 stocks on the screen:
Tapestry, owner of the Coach, Kate Spade and Stuart Weitzman brands, saw its gross margin rise to 72% in the second quarter, over 67% in the same quarter in 2019.
Coca-Cola raised its gross margin to 63% in the second quarter, above 61% in the same period in 2019.
Philip Morris International grew its margin to 70% from 65%.
Altria Group increased its margin to 66% from 64%.
Nvidia grew its margin to 65% from 60%.
These stocks have an added advantage over others on the screen. They largely aren’t economically sensitive. People still drink Coke during a recession. So if high inflation persists and the Federal Reserve is forced to lift interest rates, any potentially lower economic demand won’t damage sales much for these companies.
Write to Jacob Sonenshine at [email protected]
