value
Pricing power is the moat
The rule
A business that cannot set its own price has no real protection. A price-taker's best profit comes from the cycle, not from quality.
Where it flips
Even a strong business can lose pricing power if rivals or rules catch up. And a cyclical stock bought cheaply at the bottom can be a fine trade. The fix is to average a price-taker's earnings across a full cycle and never stretch the peak into the future.
The clearest test of a business's strength is this: can it raise prices without losing customers? A company with real pricing power (a brand, a network, a true edge) controls its own margin. A price-taker, like a commodity maker, must accept whatever price the market hands it. So its profits swing with the cycle, not with skill. At the top of the cycle these profits look wonderful and the P/E looks cheap, right before both crash.
A worked example
A metal maker earns record profit when the metal price spikes, showing a tempting P/E of 6. Value it on middle-of-cycle earnings instead and the honest P/E is 15. The "cheap" peak was the trap. [illustrative]
How to spot it
- ·profits move with a commodity price, not with management
- ·a suspiciously low P/E at the top of a boom
- ·no ability to raise prices without losing customers
Warren Buffett · Value investing writing