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You don't have to be an investor of Warren Buffett's caliber to know that happy customers make for happy shareholders.
But the link between customer satisfaction and stock performance is stronger than you might think. In fact, it's so high that you should make knowing what customers think a regular part of your investing routine.
Consider these numbers:
- A portfolio of companies with the happiest customers gained 75% from 2000 to 2004, dwarfing the 19% gain for the Standard & Poor's 500 Index ($INX, news, msgs) during the same time, according to a recent study by researchers at the Stephen M. Ross School of Business at the University of Michigan.
- In another test by the same researchers, happy-customer companies advanced 40% -- or three times better than the S&P 500 from 1997 to 2003.
- In both studies, the stocks of companies with the happiest customers were less volatile.
You can get all the dirt you need on customer satisfaction at more than 200 companies for free at this Web site. The rankings are part of the American Customer Satisfaction Index developed by the National Quality Research Center at the University of Michigan business school.
Throughout the year, it conducts around 65,000 phone interviews asking consumers if they've used certain products or services recently. If so, consumers are asked about their satisfaction with levels of quality and reliability, and whether the goods or services met their expectations. They're also asked whether they have any complaints and whether they're likely to be repeat customers. Their answers are ranked and tallied in a way that creates an overall score for a company on a scale of 1 to 100, with 100 being the highest. Researchers post both company rankings and averages for industry groups.
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If you want to use this system, the key is to go with companies that have satisfaction ratings at least 2 or 3 points above their group average. Companies get bonus points if their ratings have jumped by at least 2 points since the previous survey. Even if ratings slip for all companies in a group but one company ranks well ahead of its peers, it's likely to outperform the market, says Forrest Morgeson, a University of Michigan researcher who helped conduct the study.
Some of the reasons why happier customers make for happier shareholders should be fairly obvious. Satisfied customers are more loyal. They share the joy with their friends. There are fewer complaints to eat up employee time. Warranty costs are lower.
But other reasons may be a surprise:
- Companies with happier customers have lower employee turnover.
- They generate more cash. A 1-point increase in the customer-satisfaction rankings correlates to a 7% increase in cash flowing into a company's coffers. Happy customers also translate into more predictable cash flow, which brings down borrowing costs.
Here's a look at some other ways high customer satisfaction helps companies -- as well as a happy-customer portfolio I put together on the basis of the current rankings. I'll get to some of the pitfalls of using this approach, too.
Pricing power
Companies that have strong relationships with the consumer can typically get away with price increases, says Larry Coats, the manager of the Oak Value Fund (OAKVX). That's good for profits.This was the case last quarter with condiment maker H.J. Heinz (HNZ, news, msgs), which has a 4-point lead over its peers in the University of Michigan customer-satisfaction rankings. Indeed, "strong pricing gains" was one of the main reasons Citibank (C, news, msgs) analyst David Driscoll upgraded Heinz to a "buy" in late May, increasing his price target to $53 a share. Heinz was able to increase prices 6% in the first quarter, more than any other large-cap food company. Driscoll also upgraded Heinz because the company is launching hundreds of products.
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I also like Heinz because chief David Moran recently bought $426,000 worth of stock at $46.20 -- or around current levels. The company also has a share-buyback plan in place. It can afford that share buyback in part because those good customer-satisfaction ratings support strong cash flow. Heinz ranks near the top for cash flow among large-cap food companies, Driscoll says.
New products
Companies with high customer-satisfaction ratings also find it easier to successfully launch products. This makes sense because customers are more likely to take a chance on new gadget or goodie if the old ones gave them lots of joy.Here I have three examples. They all outshine their peers in customer satisfaction by 2 points or more, and their ratings are rising.
First, it's no surprise to find Apple (AAPL, news, msgs) in this group. Because of the user-friendly design of its iPod music player and Mac computers, Apple ranked a healthy 5 points ahead of competitors Dell Inc. (DELL, news, msgs) and Hewlett-Packard (HPQ, news, msgs) in personal computers. The iPod has helped here because of its "halo effect." Happy iPod customers have been buying Macs.
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