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The customer is always right
Using 20+ years of customer loyalty data to beat the market
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How do you find a good business? You can look at the books, the management, the growth prospects, and the news. You can try to find out what’s the public perception and what’s going on inside the company.
But the most fundamental part of a business is: the customer. In a study done at the University of Michigan, companies that scored consistently on customer satisfaction were found to produce higher returns with seemingly lower risk. I took a look at a different metric - Customer loyalty. Loyal customers can sustain your business through recessions, cut acquisition costs, and keep bringing in consistent revenue.
The theory sounds fine, but does the data bear it out? And can we use this to design a strategy that beats the market? TLDR: Yes. Here’s how you would go about it.
The primary source for this analysis is Brand Keys’ Loyalty Leaders list which is published at the end of every year, listing the top 20 to 100 brands that have inspired the most positive customer engagement across various metrics in that year.
Brand Keys is a leader in customer loyalty research, independently validated by multiple professional organizations, and they have been compiling this data for more than 20 years!1 The list ranks brands that customers love.
After fetching the data, the following rules were applied to it:
The investor will invest in this year’s top 10 companies on the first day of the next year
The companies must be publicly traded on the NYSE or Nasdaq on the day of investment.
If the same company has multiple brands on the list, the investment will be weighted proportional to that
First, let’s compare the average returns of the top 10 Loyalty Leader companies (CL10 companies) to the S&P500 over different time frames. Even after capping at the 95th percentile to remove outliers, the CL10 companies beat the S&P500 by a wide margin. CL10 outperformed the S&P500 over every time frame.
If you had started 20 years back, you would have received an extra return of more than 320% compared to the index! But of course, it’s important to see how this strategy would have worked if you had invested in different years. Here’s the difference in returns to date between the S&P500 and CL10 companies of every year, starting from 2003.
Except for two years, 2006 and 2021, the returns from CL10 companies to date are more than the returns from the S&P500 for any year, and the margin by which it beats the market is astounding in some cases!
What’s more interesting is that the best results from the CL10 would have been obtained if you had bought into them following the 2007-08 financial crisis. Buying the dip is always sound advice, but companies that had the confidence and loyalty of customers seem to have done more than 10x better even compared to the market. Case in point, Avis Budget Group, the parent company of Avis car rental, kept making the top 10 list in 2007, ‘08, ‘09, and ‘10 even when its stock had plummeted from around $30 to 75 cents. The stock is worth nearly $200 today!
There’s a catch here. Even though there were 199 investments over 20 years, these investments were split among just 36 companies because the Brand Keys list tracks the brands with the most loyalty and not companies. There were 12 companies that had more than 5 occurrences on the list. 99 out of 199 entries in the list are just Amazon, Google, Apple, and Facebook!
Of course, there’s nothing wrong with that. If tracking customer loyalty would have enabled you to invest more in these companies early on, even as far back as 2003 and 2004, then that’s a great find! You might even stumble onto the next Amazon this way. But the question is: Were the outsized results only due to investing in these companies? What about the remaining portfolio?
Here are the average returns to date of all companies that occurred on the list 5 times or more.
The average delta from these companies is 128%. But just removing the top 4 entries changes the delta from 128% to -56%. Of course, this is just looking at companies that made the list 5 or more times. There are many other companies that made the list only once but contributed to the overall returns being positive. If you consider all the companies on the list and then remove the top 4 entries, the delta is 92% which is still respectable.
Not all the returns are due to Big Tech. But it’s good to be aware that this strategy is heavily weighted towards Big Tech - and might also be equally volatile when these companies run through a bad patch4.
In fact, 20 out of the 36 companies on the list have underperformed the S&P500 to date, but the remaining companies had such outsized returns that they make up for these losses.5
Long term gains are made by companies that sustain, and companies sustain because of their customers. The data seems to bear this out as well - through ups and downs, the companies that retain the loyalty of their customers have sustained and given better returns than the market on average.
We are living in an era when the most popular brands are Tech-related. Following this strategy might be heavily weighted towards tech and swing during turbulent times, but that holds true of the market in general. If you’re looking for a high-reward strategy with moderate risk to diversify a part of your portfolio, following customer loyalty leaders is a sound strategy backed by both fundamentals and data.
Until next week…
The data used for the analysis is here.
If you enjoyed reading this, you might also like my previous articles on:
Investing in the most reputable brands in the world
Do top companies to work for also give great stock returns?
Disclaimer: I am not a financial advisor. Do not consider this as financial advice.
2013’s Customer Loyalty Leaders list was not available, but the closely related Customer Engagement list was used as a proxy instead and the companies with the most engagement were selected for that year alone.
In case the company underwent acquisition or went bankrupt, the price was tracked till the day of the event and the same price is used till today (basically, no change in returns after the merger or bankruptcy, assuming that stocks were sold at that point).
If you think the S&P500 provides protection against this, think again. Michael Batnick’s excellent article talks about how Big Tech has come to dominate the market, and chances are that you would have invested heavily in these stocks anyway.
Though I have tried to make the data as comprehensive as possible, there are a few aspects that are not captured in the analysis. Even companies that score consistently on customer loyalty go defunct, go private, or get acquired - though this should not have much of an impact on the overall returns, handling those stocks during the transition is an overhead to this strategy.