Warren Buffett might be someone you’d like to listen to when it comes to investing matters. For close to five decades and counting, Buffett has been building a formidable track record of investing success by compounding the book value of his investment holding company, Berkshire Hathaway, at an annual rate of 19.7%. With this in mind, wouldn’t it be great to know what Buffett looks out for when it comes to potential investments? Turns out, he has made it publicly known that it’s a business’s pricing power that he rates the most highly: “The single most important decision in…
Warren Buffett might be someone you’d like to listen to when it comes to investing matters.
For close to five decades and counting, Buffett has been building a formidable track record of investing success by compounding the book value of his investment holding company, Berkshire Hathaway, at an annual rate of 19.7%.
With this in mind, wouldn’t it be great to know what Buffett looks out for when it comes to potential investments? Turns out, he has made it publicly known that it’s a business’s pricing power that he rates the most highly:
“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 [emphasis mine].”
I had placed a particular emphasis in the last few words of Buffett’s quote above because it also gives us a framework to think about the businesses we may want to avoid. As Buffett’s long-time sidekick Charlie Munger once said, “Tell me where I’m going to die, that is, so I don’t go there.” There’s a lot of value to be had in negative thinking (thinking about what not to do).
So, what are some local shares that have Buffett’s dreaded trait – the lack of pricing power? The full-service carrier Singapore Airlines Ltd (SGX: C6L) and liner shipping outfit Neptune Orient Lines Ltd (SGX: N03) might fit the bill.
Source: S&P Capital IQ
The chart above plots the historical gross margins for Singapore Airlines and Neptune Orient Lines going back more than a decade.
The gross margin measures the percentage of profit you have for each dollar in sales you make after deduction of all the costs directly related to the sale
The trends in gross margin, as well as a comparison of it with a company’s industry-peers, can be a good reflection of how much pricing power the firm has. If its business lacks pricing power, the company would be unable to pass on any cost increases to its customers, leading to a falling – as well as low – gross margin.
With the erratic and steadily shrinking gross margins Singapore Airlines and Neptune Orient Lines have seen over the years, it’s a strong clue that the duo sorely lack any pricing power in their businesses.
A Fool’s take
It’s perhaps no surprise to find that Singapore Airlines and Neptune Orient Lines have been long-term laggards in the stock market.
Since the start of 2004, the duo have had total returns (capital gains plus reinvested dividends) of 93% and minus 4% respectively; the Straits Times Index (SGX: ^STI), Singapore’s stock market barometer, has grown by 95% in price alone over the same duration.
None of the above is meant to say that Singapore Airlines and Neptune Orient Lines would necessarily be bad investments going forward. The business environment and the stock market are dynamic places – things can change, or their shares could become so cheap (relative to their intrinsic business values) such that investors can’t ignore them.
But, for investors who want to find great businesses to hold for the long-term – and keeping Buffett’s framework for this matter in mind – they’d need to tread carefully with Singapore Airlines and Neptune Orient Lines given what we’ve seen.
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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.