The Positives of Pricing Power

 | Jul 22, 2014 | 3:00 PM EDT  | Comments
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Stock quotes in this article:

cmg

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wmt

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ko

Economics teaches us the general laws of supply and demand. Also taught is the basic idea that in order to sell more goods, prices should be reduced. Wal-Mart (WMT) built a half-trillion-dollar-a-year business doing just that. But as with any theory, they are never 100% correct.

Rare and glorious is the business that possesses that magical ability to do the unthinkable: raise prices and maintain or increase demand. Simply put, the ability to raise prices without disturbing volume equals one thing: an exceptional business. Coca-Cola (KO) is a perfect example.

Today we have a more recent example in the most unlikely of places: restaurants. Virtually all restaurants concepts fight for consumers over prices. Whether it is a $0.99 burger war, the $4.99 pizza battle, or even the casual dining establishments that promote "two dinners for $25," it's all about price for the restaurant industry.

That is unless you are Chipotle Mexican Grill (CMG). Over the past several quarters, Chipotle has been suggesting that price increases were coming. Many of them occurred last quarter. In fact, I visited several Chipotle's in a couple of different states when I was traveling on business last week and, indeed, the prices have gone up by approximately 10%. Monday, the fast casual chain of burritos and tacos reported a 26% increase in profit. Same-store sales increased by more than 17%, while revenue jumped by nearly 30% from the year-earlier quarter. All this growth came amid price increases.

Chipotle is a different restaurant company. The company has a marketing program that is second to none, and the Chipotle brand has become incredibly valuable. Five years ago, the customer base was homogenous. Today, Chipotle's consumers are incredibly diverse.

Shares jumped about 13% in midday trading and appear headed for an all-time high at more than $667 per share, valuing the company at more than $20 billion, or nearly 60x trailing earnings.

I can't buy the shares. Chipotle, perhaps, has the most optimistic viewpoint of any stock in the market today. That being said, the shares I picked up for $250 several years ago aren't going anywhere. I suppose if shares continue to climb any higher, I would consider selling -- only to look to buy later at a lower price. But Chipotle is a different type of restaurant operator. Yes, one day, growth will probably plateau to a more natural level. But with less than 2,000 locations, that natural state is a long way off.

Meanwhile, this business illustrates the awesome power of pricing power, and a very sticky customer base. If you can find others, look at those businesses very carefully.

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