Wouldn’t it be great to know what billionaire investor Warren Buffett looks for when it comes to him evaluating a business for investment? Turns out, he has given very clear indications that it is a business’s pricing power that he rates the most. According to Bloomberg, this is what Buffett said when he was interviewed by the Financial Crisis Inquiry Commission a few years back: “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….
Wouldn’t it be great to know what billionaire investor Warren Buffett looks for when it comes to him evaluating a business for investment? Turns out, he has given very clear indications that it is a business’s pricing power that he rates the most.
According to Bloomberg, this is what Buffett said when he was interviewed by the Financial Crisis Inquiry Commission a few years back:
“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 10 percent, then you’ve got a terrible business.”
Since taking control of Berkshire Hathaway in the 1960s when it was still just a sleepy textile manufacturer, Buffett has transformed the company by using Berkshire’s cash to acquire other companies and buy shares of other publicly-listed firms. Over the years, he has made some famous investments, with perhaps none more so than his purchase of shares of fizzy drinks maker Coca-Cola that first started in 1988.
In 1998, 10 years after he first started buying Coca-Cola’s shares, Buffett illustrated the extent of influence that the company’s pricing power had on his decision to invest in it:
“Right now the pricing power [for Coke] might be tough, but you think a billion servings a day for a penny each or $10 million per day. We own 8% of that, so that is $800,000 per day for Berkshire Hathaway. You could get another penny out of the stuff. It doesn’t seem impossible. I think it is worth a penny more. Right now it would be a mistake to try and get it in most markets. But over time, Coke will make more per serving than it does now. Twenty years from now I guarantee they will make more per serving, and they will be selling a whole lot more servings. I don’t know how many or how much more, but I know that.”
Given that shares of Coca-Cola have been a massive winner for Buffett (it’s up more than 1,000% on aggregate!) since his purchases, it’s perhaps useful for us investors here in Singapore to look at some firms that might possess pricing power.
Neo Group’s in the events catering business and is also involved with food & beverage retail. The company currently has four catering brands – Neo Garden Catering, Orange Clove, Deli Hub, and Best Catering – which targets different market segments all the way from mass market to premium. One particular statistic about Neo Group’s catering brands lead me to believe that it possesses pricing power: The gulf between its sales growth and the increase in number of guests served. Here’s an example from the company’s latest financials for its financial year ended 31 January 2014 (FY2014):
|Brand||Year-on-year sales growth||Year-on-year increase in number of guests served|
Source: Neo Group’s presentation slides for FY2014
Vicom on the other hand has two main business segments: 1) Vehicle inspection and testing; and 2) commercial and industrial testing and inspection for companies in a wide array of industries including Oil & Gas, Aerospace, Marine, Food, Electronics, Construction, Building & Facilities, and Environmental.
Vicom’s first segment contributed roughly two-third of its overall profit in 2010 (the company stopped its segmental reporting in that year) and it is where I think the company does indeed possess pricing power. In Singapore, vehicle owners have a choice of nine centres island-wide which provide these particular services. The catch here is that Vicom runs seven out of those nine centres. Given such dominant market share, it seems logical that the company could easily raise its fees if it so wishes. With a number of those tests and inspections being mandated by the government on a fixed schedule, it’s also not something vehicle owners can choose not to undertake.
The two shares have been great long-term market beaters. Neo Group got listed in July 2012 at S$0.30 per share and has gained 207% in price alone since; in contrast, the Straits Times Index (SGX: ^STI) has increased by only 12.3% to 3,356 points. With Vicom, it has delivered capital appreciation of 682% since the start of 2004, handily outpacing the Straits Times Index’s corresponding gain of 90%.
But here’s a note of caution. Although Neo Group and Vicom both seem to possess the rarefied ability to raise the prices of their products and services, this is not to say that their shares would certainly do as well going forward as compared to how they’ve done in the past. The probability of Neo Group and Vicom’s shares turning in a market-beating performance in the future would also hinge on other factors like their valuation, balance sheet strength, quality of earnings, and honesty and integrity of management, among other factors.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing owns shares in Berkshire Hathaway and Neo Group.