Connecting Product Prices to Stock Prices
There was a great piece of analysis on the seekingalpha.com website by the folks at Trefis that connects changes in the average selling price (ASP) of Motorola mobile phones to changes in stock price forecasts. As I review company research and commentaries I am surprised by how little attention is paid to pricing. On the one hand most firms rightfully consider pricing to be a very sensitive subject. Public discussions of pricing are fraught with potential competitive and legal problems. On the other hand pricing is the longest, strongest financial lever that there is. In addition, pricing power is perhaps the most compelling sign that a firm has a strong market position and a compelling story to tell investors. As such my sense is that many analysts could do more to understand it. Furthermore pricing professionals exacerbate the problem through an inability to connect their actions to measures that investors care about. Without this linkage, pricing often fails to make the cut as an essential part of the dialog that senior management has with investors.
Here are a few key points of analysis that can help paint a clear picture of how a firm is managing pricing. For each major product line:
- What is the delta between list prices and ASP? What are the trends? This is one of the most fundamental measures of pricing performance. Firms that are heavily reliant on discounting to drive sales are not in a secure position and tend to become even more reliant on discounting to move units as competition intensifies.
- What impact do changes in ASP have on earnings and share price projections? This is what the Trefis analysis is doing. In the Motorola example a 1% increase in ASP correlates to roughly a 0.6% increase in share price. Keep in mind that according to their methodology the handset business accounts for only 27% of the share price. It’s easy to see how the share prices of firms that have fewer product lines are going to be far more sensitive to product pricing performance.
- What is the sensitivity of revenue and earnings projects to changes in price, product volumes, and product mix? This is really a test of the quality of revenues. Are key products falling out of favor and/or requiring more discounts to move them? Is the company ceding the low end of the market to more aggressive competitors and thus seeing the size of its market footprint shrink? Are they doing desperate things in the market to hit revenue projections?
- Finally how does the firm being analyzed compare to its principal competitors? At the end of the day, firms that have pricing discipline will outperform less disciplined competitors, their revenue and earnings projections will be more reliable, and they will have healthier businesses over the long run.
If pricing professionals want to rivet the attention of senior management on the benefits of connecting prices to value, they have to become much more proficient in speaking the language of value themselves.