Over the last couple of years, there hasn't been a single topic that has attracted more attention than inflation. And there's a good reason for this situation. The Consumer Price Index, a key measure of inflation in the U.S. economy, reached a 40-year high in June 2022.
This prompted the Federal Reserve to hike interest rates aggressively starting in 2022. The result was poor stock returns last year. Even though the CPI has been cooling down meaningfully in recent months, some investors might still be worried about the impact of rising prices across the economy.
I'm here to tell you that not all hope is lost. If this sounds like your mentality about the macro environment, then buying stocks with one magnificent trait could be the smartest move you can make in 2024.
Pricing power is a wonderful quality
"The single most important decision in evaluating a business is pricing power," Warren Buffett once said. "If you've got the power to raise prices without losing business to a competitor, you've got a very good business."
Why is pricing power so important when you expect inflationary conditions to continue? If a company can successfully offset rising costs with higher pricing that its customers don't flinch at, then inflation quickly becomes less of a concern.
There are numerous real-world examples of this phenomenon. Look at luxury automaker Ferrari (RACE 2.49%). Because it caters to the ultra-wealthy, it can keep raising prices on its supercars, which are met with even stronger demand due to exclusivity and brand power.
Or take a more mass-market business like Chipotle Mexican Grill (CMG 2.41%). Even though management has increased menu prices multiple times in the past couple of years thanks to rising costs for food, labor, and paper products, consumers still believe they are getting tremendous value.
Netflix (NFLX -0.63%) is another example. In the U.S., its most developed market, the company has asked members to pay more for its streaming service many times over the past decade. Yet the subscriber base keeps expanding over time.
These businesses can't increase prices aggressively and indefinitely, or they risk losing customers and leaving revenue on the table. But it's very encouraging to know that their operations benefit from pricing power.
Image source: Getty Images.
Inflation is a complex beast
What's interesting about inflation is that, for an economic topic that so many people pay close attention to, no one still has any idea what's going to happen in the future. Look at the Federal Reserve for the perfect demonstration of this point. This is a group of central bankers who are the most well-educated economists in the world, and they were convinced that inflation was just transitory in the summer of 2021, a wildly incorrect assessment.
The fact that these so-called experts have no clue which direction inflation is going means that the average investor, armed with less data, analytical capabilities, and time on their hands, surely doesn't know what will happen with prices across the economy.
That's why owning shares of businesses that exhibit pricing power is so critical, especially right now. We don't need to make any predictions about inflation. These companies have differentiated product offerings that customers are willing to pay for, no matter what the macroeconomic picture looks like. And that's a clear advantage from a portfolio management perspective.
There is a reason to believe that the next decade will be more inflationary than the last. The Fed is already signaling rate cuts next year, an accommodative stance. Lower interest rates, coupled with unlimited money printing to support a massive and growing debt burden, can undoubtedly spur inflation. This is something to pay close attention to ahead.
All of this leads to the conclusion that pricing power should be one of the top characteristics that investors look for in potential investments in 2024 and beyond. I suspect that a portfolio full of these types of businesses will do well over the next decade.