The power of pricing

04/02/19
  • Q1 earnings season will kick off next week
  • Earnings are widely expected to decline year over year
  • Stocks with strong “pricing power” cited as attractive buys

What do Starbucks (SBUX), Adobe (ADBE), Sherwin Williams (SHW), and Edwards Lifesciences (EW) have in common?

Absolutely nothing, except that they all fall under the umbrella of stocks with so-called high “pricing power,” a phrase you may be hearing more about as Q1 earnings season gets underway.

Basically, it refers to a company’s ability to pass on increased costs of doing business (its inputs) to its customers with, for lack of a better word, impunity. So, for example, if Starbucks raises the price of a latte by 5 cents, the assumption is that we’ll keep on sippin.’

If that sounds like a dubious proposition to you, consider this: The last time Starbucks made news about a price hike was the middle of last year, when the cost of a cup of joe went up at thousands of locations by 10–20 cents (the third increase in three years).1 Since then, Starbucks has topped its earnings and revenue numbers each quarter,2 and its stock price is up more than 50% since last June.

Starbucks (SBUX), 7/18/16–4/1/19. Starbucks (SBUX) price chart. Higher prices, higher revenues, higher stock

Source: Power E*TRADE


The reason you may be hearing more about stocks with pricing power is because many analysts expect the upcoming earnings season (which will kick into gear late next week) to be a departure from the past few record-breaking quarters.

Many companies have been downsizing their 2019 performance estimates (aka “guidance”), and Q1 is widely anticipated to be the first quarter since Q2 2016 with a year-over-year drop in earnings. Goldman Sachs analysis pointed out that all 11 S&P 500 (SPX) sectors have had negative earnings revisions since the start of 2019, which is one reason the firm recently recommended stocks with high-pricing power.3

Although that’s advice for investors, it may also be a factor for short-term traders as companies start posting their Q1 numbers. Just because a company is cited as having pricing power doesn’t mean its stock can’t go down, but it may be one factor among several that traders consider when looking for long-side possibilities during what could be a turbulent earnings season.

Sherwin Williams (SHW), 7/16/18–4/1/19. Sherwin Williams (SHW) price chart. Upside vs. downside

Source: Power E*TRADE


As just one example, a trader considering different potential breakout trades may notice that SHW is a widely referenced pricing-power stock, which may make an upside breakout of its triangular consolidation more attractive than a downside breakout (chart above).

Different pieces of information can carry different weight at different times in the market. Traders always need to be ready to adjust to a shifting landscape.

Market Mover Update: Cisco (CSCO) broke out to a new long-term high yesterday, while Ubiquiti Networks (UBNT) followed up on Friday’s trading range breakout with a 3%-plus intraday rally (see “Sector gets wired”).

The crude oil spigot was still open on the first day of Q2, with May WTO crude oil futures (CLK9) gaining more than 2% and pushing above $61.50/barrel.

Yesterday’s Retail Sales number was weaker than expected (although last month’s was revised upward), while manufacturing and construction data topped estimates.

Today’s numbers (all times ET): Durable Goods Orders (8:30 a.m.).

Today’s earnings include: Walgreens Boots Alliance (WBA), Dave & Busters (PLAY), GameStop (GME).

 

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1 Fortune. Starbucks Quietly Raises Prices—Again. 6/7/18.

2 StreetInsider.com. Starbucks Corp. (SBUX) Earnings. 4/1/19.

3 CNBC.com. Goldman: Earnings outlook is getting grimmer by the day, so hide out in companies with big margins. 4/1/19.

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