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EV, media and cyclical tech among Capital’s top tilts

Pricing power key amid confluence of uncertainties

Investment director at Capital Group, Matt Reynolds, outlines four uncertainties that are influencing equities markets at the moment. The first is the supply-side-induced inflation; the second is the aggressive monetary tightening to combat it over time, the third is the longer-term effects of the China zero-Covid policy lockdowns; and finally, the eventual outcome of the Russia-Ukraine war.

Inflation readings in particular have spread to companies throughout the entire market as a result of the four uncertainties. During times of high inflation, Reynolds looks for companies that can grow their pricing power. An indicator of pricing power is higher gross margins together with the stability in those gross margins.

“This allows companies to pass-through raw price increases straight through to the customer. Examples are consumer businesses with their strong brand recognition; software and services companies; essential health services; and semiconductor companies with proprietary chip designs. All possess the ability to raise prices,” says Reynolds.

  • Given that you want an investment in this type of environment that sees its earnings grow faster than inflation, this will often point to higher-growth companies, which are often profitless. These companies are the hardest hit in a rising inflation environment, particularly if the arrival of those earnings is longer-dated. An attractive area to look at is companies that are growing dividends. They can offer a measure of resiliency against inflation and interest rate rises.

    Companies that have a strong commitment to raising dividends over time are usually the ones that can record positive dividend growth. But it’s not always about searching for the highest yield. The highest yielding stocks had the lowest returns. The sweet spot, is companies with a dividend yield of around 3-4 per cent, because of their stable balance sheets.

    Investors need to tread carefully in sectors such as property, education and gaming. The zero-Covid strategies in China have also added to the complexity of the environment. But there are opportunities. Reynolds highlights four sectors that contain companies that are durable to this environment.

    1. Tech trifecta – Exposure to software, semiconductor and cloud computing industries.
    2. Healthcare sector – Life-changing drugs are being developed faster than ever. Investing in the suppliers and contract testing companies has been a source of long-term growth.
    3. Electric vehicles – Thanks to government incentives, the move to decarbonisation and falling EV parts prices. The sector is in the very early stages of an autonomous motor vehicle rollout.
    4. And finally, the media industry presents some great opportunities. It is where the landscape is fundamentally changing, in the way in which people communicate and entertain themselves.  Interactive gaming is a huge area.

    Reynolds concludes by saying, “I think a new market environment presents new opportunities, stock-specific ideas driven by fundamentals; in particular, companies that can take advantage of changes that are occurring in the world, and often as themes or broad ideas for everyone to invest in.”

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