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Where To Invest When Prices Aren’t Rising

The drop in oil prices has gone from being just an interesting quirk to something that has sent markets berserk. Hardly a day goes by without an unwitting comment from an oil analyst or a corporate announcement from an oil-related company causing unwanted stock-market stir.

Meanwhile, a former advisor to Saudi Arabia’s minister of petroleum recently added fuel to the fire. Mohammed al-Sabban hinted that prices could go as low as possible to flush out marginal producers.

He added that his country could cope with low prices for at least eight years. His views have raised more questions than answers. It would seem that the current state of flux in the stock market over oil prices could remain for as long as it is needed for supply and demand to return to balance.

Elsewhere, low oil prices have raised another unwanted spectre, namely, deflation.

Oil, which is an important input cost for many industries, can have a significant impact on prices. That is provided those lower oil prices are passed on swiftly. The upshot is that the price of goods from foods to fuel could fall, which in turn could drive mild inflation into unwelcome deflationary pressures.

Interestingly, deflation can be as perilous as rising prices for businesses. After all, inflation and deflation are just different sides of the same coin.

Thing is, pricing power is one of the key strengths of a robust business. A good company should be able to raise prices without worrying about an adverse impact on sales. In a deflationary economy, the ability to resist cutting prices when others are cutting is paramount.

Luxury goods retailers, for example, cater for customers who rarely look at price. Or as a retailer of luxury cars once quipped: “If you have to ask how much, then you shouldn’t even be in my showroom.

As arrogant as that might sound, it underlines the importance of pricing power. Upmarket fashion company, The Hour Glass (SGX: E5P), could fit the bill of a company with pricing power. Over the last four years, the company has been able to main a consistently high gross margin. This in turn has fed a consistently high return that its investors have enjoyed on their investment.

Food producers that command strong brand loyalty should be able to resist cutting prices in time of deflation too. Old Chang Kee (SGX: 5ML), for instance, has been able to maintain a good operating margin for almost the last ten years. It makes around S$7 of operating profit for every S$100 of goods sold. Thanks to a healthy asset turnover too, the curry-puff maker has delivered nearly S$16 of profit for every S$100 of shareholder equity.

Fellow food producer BreadTalk (SGX: 5DA), with its suite of facades and frontages that include Toast Box, Din Tai Fung, Thye Moh Chan and Food Republic is another company that has exhibited strong pricing power over the years. Its gross margin of some 50% must be the envy of many.

Low oil prices have introduced a new unknown to the stock market. There was a time when any talk of a halving of crude prices would not have been entertained, even as a remote possibility.

But a halving of oil prices has happened. That said, investors in companies with strong pricing power should have nothing to fear. As Warren Buffett once said: “It is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

And any oil priced induced market volatility could provide just the opportunity to invest in those wonderful companies at fair prices.

A version of this article first appeared in the Independent on Sunday.

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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 Director David Kuo doesn’t own shares in any companies mentioned.