As Inflation Soars, Look for Pricing Power
Before I delve into my inflation-related topic for today, let’s take a quick look at the media circus surrounding Elon Musk and social media platform Twitter (NYSE: TWTR).
Financial news television has been providing wall-to-wall coverage of Elon Musk’s $43 billion bid for Twitter. From an investment standpoint, there’s no reason for you to care. Twitter is a stagnant stock and billionaire bad boy Musk enjoys being a prankster.
As editor-in-chief of our publication Marijuana Investing Daily, I’ve become well-versed in cannabis culture. I immediately detected a pot-related joke in Musk’s per-share offer for Twitter of $54.20.
Marijuana adherents recognize April 20 (or 4/20) as an international holiday for weed. It seems that Elon Musk, world’s richest man and inveterate pot smoker, is pulling our leg.
Shrewd investors learn to recognize media hype and tune it out. The Tesla (NSDQ: TSLA) CEO’s true goal with Twitter is anyone’s guess. I suspect that a pump-and-dump scheme is at work, but I’ll leave Mr. Musk’s dubious antics to the SEC.
Instead, I want to look at how nimble companies are staving off inflation. As prices soar, their respective industries confer investment opportunities.
Inflation continues to weigh on stocks. The major U.S. stock market indices performed as follows Thursday: the Dow Jones Industrial Average -0.33%; the S&P 500 -1.21%; the NASDAQ -2.14%; and the Russell 2000 -0.99%. The New York Stock Exchange and NASDAQ are closed on Good Friday.
It’s been a busy week for earnings reports. For first quarter 2022, with 7% of S&P 500 companies reporting actual results, 77% of S&P 500 companies have reported a positive earnings per share (EPS) surprise and 80% have reported a positive revenue surprise, according to research firm FactSet (the numbers are up-to-date as of April 14).
For Q1 2022, the blended EPS growth rate for the S&P 500 is 5.1%. “Blended” combines actual results with projected ones. On March 31, the estimated EPS growth rate for Q1 2022 was lower, at 4.7%.
We’re seeing better-than-expected quarterly performance. Positive EPS surprises reported by financial services companies this week were the largest contributors to the improvement in the EPS growth rate.
Spotlight on profit margins…
Given rising consumer and producer prices, it’s impressive that many companies have been able to maintain net profit margins.
The blended net profit margin for the S&P 500 for Q1 2022 is 12.1%, which is below the year-ago net profit margin of 12.8% and below the previous quarter’s net profit margin of 12.4%.
If 12.1% turns out to be the actual net profit margin for Q1, it would represent the third consecutive quarter in which the net profit margin for the index has fallen.
But that’s not the whole story. The figure of 12.1% exceeds the five-year average net profit margin of 11.2%; it’s also the fifth-highest net profit margin reported by the S&P 500 index since FactSet began tracking this metric in 2008.
As of April 14, the estimated net profit margins for Q2 2022, Q3 2022, and Q4 2022 are comparatively healthy, at 12.7%, 13.1%, and 12.8%, respectively (see chart).
Many companies have been adroitly handling inflation by streamlining, implementing efficiencies, and passing along their higher input costs to customers.
We’ll see if companies can continue protecting margins. Recent produce price index (PPI) data suggest that inflation will persist for a while; the PPI is forward looking and the reading for March was hot.
Also keep in mind, Q1 numbers are from a quarter that’s in the rear-view window. Second-quarter numbers may paint a bleaker picture.
As an investor, where should you turn? During periods of inflation and rising rates, value stocks tend to outperform. Unemployment remains low and economic re-opening continues, with U.S. domestic product growth still on track to hit 3% to 4% this year.
Bargain hunting among quality cyclicals makes a lot of sense now. Companies with pricing power and low capital needs are especially appealing. A firm can stave off inflation, if it can raise prices without losing customers. Brand loyalty is a big plus.
Firms with the strongest pricing power are those that provide essential products and services that people can’t live without. These industries include consumer staples, health care, pharmaceuticals, transport (e.g., railroads and shippers), and real estate.
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John Persinos is the editorial director of Investing Daily.