When picking stocks, bet on pricing power

May 6, 2013, 12:35 PM UTC
Illustration: John Wilson

For consumers, rising prices are no fun. But when it comes to investing, they can be the key to choosing winning stocks. No less an authority than Warren Buffett has said that the ability to hike prices is the single most important factor to consider when evaluating a business. “Pricing power is the key to sustainable earnings growth,” says Vadim Zlotnikov, chief market strategist at AllianceBernstein. “There is clear evidence that shares of companies with pricing power dramatically outperform their peers.” With that in mind, here are three Fortune 500 companies that have proved their pricing leverage.

Start with agricultural giant Monsanto (No. 206). The company is the world’s leading developer of genetically engineered corn, soybeans, and other crops designed with special characteristics (such as resistance to herbicides and insects) that can’t be obtained through conventional methods. Farmers are willing to pay a premium for the seeds because they reduce costs and increase crop yields. Indeed, Monsanto was able to hike seed prices by 10% in 2012 and still increase the volume sold by 7%, notes J.P. Morgan Chase analyst Jeffrey Zekauskas. Monsanto’s management is forecasting that in 2013 the company will, for the third consecutive year, grow earnings per share by more than 20%.

The uncertain economy has led many consumers to cut back on food spending. But not when it comes to the small indulgences sold by Hershey (No. 384). Since 2011, the maker of Hershey’s Kisses and Reese’s Peanut Butter Cups has hiked its prices by about 10% overall — with no negative impact on unit sales. And during the first quarter of 2013, volume grew 9%, even as the company further raised prices. At the same time, Hershey has benefited from lower input costs for cocoa and sugar. The result: fatter margins and earnings. Hershey expects earnings per share to increase by a healthy 10% to 12% for 2013. Despite the stock’s big rise over the past year, Hershey remains one of the top picks of Credit Suisse food analyst Robert Moskow.

Pricing power can also come from industry consolidation, as illustrated by the U.S. rental car industry. The 2012 purchase of Dollar Thrifty by Hertz Global Holdings (No. 293) means that there are now eight rental car brands owned by just three companies — Hertz, Avis Budget Group, and Enterprise — which together control about 90% of the U.S. market, notes Miller Tabak analyst Michael Broudo. And that bodes well for pricing power. Indeed, prices at Hertz increased by more than 5% in 2012 and rose another 6% in January 2013. Rental volumes didn’t suffer, largely because Avis and Enterprise likewise hiked prices in recent months. That spells good news for investors: Hertz expects to generate compound annual revenue growth of 12.5% to 13.5% over the next three years. If the cost of your next rental is going up anyway, you may as well profit in the process.

A former compensation consultant, Janice Revell has been writing about personal finance since 2000.

This story is from the May 20, 2013 issue of Fortune.