A few days back, my mom had asked me a simple question: How do you find a great business? Her question led me to recall a great example that billionaire investor Warren Buffett had given in a 1991 lecture at the Notre Dame Faculty. Hedge fund manager Whitney Tilson had kept a transcript of the lecture and this is what Buffett said: “A couple of fast tests about how good a business is. First question is “how long does the management have to think before they decide to raise prices?” You’re looking at marvelous business when you look in the…
A few days back, my mom had asked me a simple question: How do you find a great business? Her question led me to recall a great example that billionaire investor Warren Buffett had given in a 1991 lecture at the Notre Dame Faculty.
Hedge fund manager Whitney Tilson had kept a transcript of the lecture and this is what Buffett said:
“A couple of fast tests about how good a business is. First question is “how long does the management have to think before they decide to raise prices?” You’re looking at marvelous business when you look in the mirror and say “mirror, mirror on the wall, how much should I charge for Coke this fall?” [And the mirror replies, “More.”] That’s a great business…
…The ability to raise prices – the ability to differentiate yourself in a real way, and a real way means you can charge a different price – that makes a great business.”
Put simply, one of the hallmarks of a great business is its ability to raise prices without losing customers in the process.
It’s a valuable trait to have for any business because this protects the company against cost-increases which in turn can help safeguard its profits. In addition, the ability to raise prices would also mean that a company has the ability to grow its business for years on end even if the number of customers it can sell to is stagnant or only inching up slowly.
For investors, this is a very useful tool-kit to add to our investing arsenal because the price of a share will eventually reflect the strength and performance of its underlying business and it’s thus great to know what makes for a strong business.
Keeping all these in mind, what are some of the companies in Singapore which might possess pricing power? Healthcare services provider Raffles Medical Group Ltd (SGX: R01) might be one.
As you can see in the chart below, Raffles Medical’s Hospital Services business segment (which houses most of the business activities of the company’s flagship Raffles Hospital) has displayed strong and consistent revenue growth since 2002 (the year Raffles Hospital was officially opened):
Source: S&P Capital IQ; revenue figure includes inter-segment transactions
In a recent chat I had with the company’s investor relations department, I found out that the Hospital Services segment’s top-line growth in recent years had come about from both volume growth and pricing increases and both factors had a roughly equal-split in terms of importance. The fact that Raffles Hospital could raise its prices and still treat more patients can be seen as a clue that Raffles Medical may perhaps have pricing power.
This may be a strong factor behind Raffles Medical’s impressive profit growth – the company’s earnings had jumped 14-fold from S$4.5 million in 2002 to S$67.6 million in 2014 – and subsequently, its market beating share price returns. To the latter point, Raffles Medical’s shares have gained 1,460% in price from S$0.29 at the start of 2002 to S$4.55 today; over the same timeframe, Singapore’s market barometer, the Straits Times Index (SGX: ^STI) has grown by just 105% in price.
A Fool’s take
Buffett places a special emphasis on a business’s pricing power because it can help do wonderful things for the business’s results. This then in turn can lead to great investment returns.
Do you know of any more companies which might possess formidable pricing power? If you can find one, then you might just have found yourself a worthy investment candidate (provided its share price is not too pricey of course!). And oh – please share the names of the companies in the comments section below!
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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 Raffles Medical Group.