Why I’d buy companies with pricing power to comfortably beat the ASX index

A young boy sits on his dad's shoulders while both flex their muscles.A young boy sits on his dad's shoulders while both flex their muscles.

The ASX share market is a great place to find potential investments that can perform well. Some of them, with the ability to increase prices, can outperform the S&P/ASX 200 Index (ASX: XJO) right now.

A high inflation environment is generally not what society wants – that’s why central banks like the Reserve Bank of Australia (RBA) and the US Federal Reserve are increasing interest rates so much to bring down overheated demand in the economy.

But, while inflation isn’t a good thing for many households, there are a number of companies that are benefiting. This economic environment could enable them to achieve good shareholder returns and beat the ASX 200 index.  

What is pricing power?

An easy way to think of pricing power is the ability to increase prices for customers without much detrimental impact on demand.

Think of commodity traders like iron ore and copper shares or farmers. If they want to sell their product, they have to sell at the going rate, or customers will just go to the next seller for a better price.

ASX mining shares just have to bear the cost of higher wages and so on, regardless of what commodity prices are doing.

But price makers have much more control over the price they charge.

Think of a business like an airport – if a traveller wants to fly or park their car at the airport, they don’t have much choice but to pay the necessary cost. If the airport increases the prices, visitors would have to pay up or simply not use the airport.

Here are two ASX shares that are passing on cost increases (and perhaps more) to customers, which could enable them to continue to beat the ASX index.

ASX shares with pricing power

Coles Group Ltd (ASX: COL) is a consumer staples stock and one of the largest supermarket businesses on the ASX. Food inflation has been one of the key inputs of inflation in Australia.

Coles (and Woolworths Group Ltd (ASX: WOW)) have been passing higher prices of meat, packaged goods, fruit and vegetables onto customers. But, if we dig a little deeper, we can see that Coles’ gross profit has also increased, meaning it’s passing on more than just the cost increase of products.

In the FY23 first half result, Coles supermarkets’ gross profit margin improved by 43 basis points (0.43%) to 26.5%. For the overall continuing business, it achieved sales revenue growth of 3.9%, while net profit after tax (NPAT) grew by 11.4%.

This helped fund a 9.1% dividend increase. All of those numbers are helpful for shareholder returns. Indeed, the Coles share price has gone up by 11.3% this year to date, as we can see on the chart below, beating the ASX 200 index return over the same period of 4.6%.

Xero Limited (ASX: XRO) is another ASX share that is passing on a strong price increase which can help the company’s earnings. Last year, the tech company announced impressive increases in its Australia, New Zealand and United Kingdom markets.  

In the company’s FY23 half-year result, its average revenue per user (ARPU) increased by 13% to $35.30. The business reported a 30% increase in operating revenue, while free cash flow jumped 145%.

Xero recently revealed its plan to improve its profitability, balancing growth and profit. Xero will report its FY23 result soon, so we’ll get more insights.

Improving margins appears to have been a key driver for the Xero share price rising around 20% since 8 March 2023, as we can see on the chart below.

The post Why I’d buy companies with pricing power to comfortably beat the ASX index appeared first on The Motley Fool Australia.

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Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has positions in and has recommended Xero. The Motley Fool Australia has positions in and has recommended Coles Group and Xero. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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