Inflation is now running at a record 40-year high in the UK. This not only harms consumers, it often damages the profit margins of companies too. This is especially true for those firms that are not in a strong enough position to raise prices. So I’m bearing inflation in mind when looking for stocks to buy right now.
Finding inflation-resistant stocks boils down to identifying which companies are going to be able to pass on price increases to their customers. Companies that can do this are said to have pricing power.
It’s something Warren Buffett specifically looks for when assessing a potential investment.
The single-most important decision in evaluating a business is pricing power. If you’ve got the power to raise prices without losing business to a competitor, you’ve got a very good business. And if you have to have a prayer session before raising the price by a tenth of a cent, then you’ve got a terrible business.
Warren Buffett
I think the following two companies have strong pricing power, and don’t need to have “a prayer session” before raising prices.
Ferrari
The number of wealthy people worldwide has been gradually increasing over the years. This rise in global wealth and consumption continues to underpin the growth story at luxury carmaker Ferrari (NYSE: RACE).
The company is raising prices again early next year. Yet the demand for Ferrari’s supercars seems to only increase as the prices go up. That’s why analysts at Morgan Stanley have said: “Ferrari is as close to recession-proof as it gets”.
There was more evidence of that this week in Ferrari’s Q3 2022 results. The company upwardly revised its full-year guidance across all metrics. Management said: “Today, we continue to manage an outstanding order book: with the exception of few models, our entire range is sold out”.
I do see potential risk in the valuation of the stock, though, as it currently carries a price-to-earnings (P/E) ratio of 39. This high valuation probably means Ferrari’s improved outlook is already priced into the stock. Any operational hiccups from the company in the future could certainly send the shares lower.
However, I think there are plenty of wealthy buyers out there to continue driving demand for the company’s supercars. So I’m going to open a position in the stock very soon.
Diageo
Another inflation-resistant stock I like is British drinks giant Diageo (LSE: DGE). Because of its pricing power, Diageo has some of the best gross profit margins in the FTSE 100.
In its full-year 2022 report, Diageo noted that premium-plus brands drove 71% of organic net sales growth. The company’s premium-plus brand category includes drinks such as Don Julio tequila, Johnnie Walker whisky, and popular tequila label Casamigos. These premium brands are where the firm has the most pricing power.
However, the outlook for the global economy remains gloomy. So the obvious risk with the stock is that a global recession could severely reduce demand for Diageo’s alcoholic beverages.
Still, drinkers tend not to switch from premium brands to cheaper alternatives. Even during recessions, these brands are put in the ‘affordable luxury’ category. For me, this gives the stock a defensive quality. That’s why I’m going to add to my position in the coming days.
