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In choosing stocks too, the customer comes first

Could measuring customer satisfaction be a good way for choosing stocks that will do well?

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How do stock investors choose which company to invest in? Most people, even those who are not investors, understand that the primary driver is the company's financial results, along with other information like its industry and business outlook, management quality, regulatory environment, the current stock price, etc.

If you think about it, all this data and information is irrelevant by itself. After all, it's all information about the past, by definition. However, what you as a saver should actually be interested in is the future. The money you will make depends on how a company will do in the future and what will happen to its stock price in the future. Since you cannot know the future, you use past information as a proxy for the future. If a company has been growing its profits in the past, then it's likely that it will do so in the future as well. If the management has run the company well in the past, then there's a likelihood that it will continue to do so in the future as well. Although we almost never think of equity research in these terms, it's a way of foretelling the future.

Might there be other indicators that will enhance our ability to foretell the future? Some time back, I came across a very interesting decade-long experiment that a group of designers did in the US. Back in 2006, a group of people running a design firm had an idea that companies' ability to make money for shareholders was dependent on the 'user experience' that their customers had. User experience is sometimes taken as a near-synonym of 'user interface', as of a website or an app, but really it's a broad term which encompasses a customer's entire experience with a product or service.

They decided to put their money where their mouth was and invest in companies that they thought offered the best experience. As it happens, 2006 was an interesting year to do so. Google had just released maps, Yahoo looked like it still might make something of itself, and Blackberry dominated the market for what we would eventually call smartphones. Apple was rumoured to be working on a phone, which turned out to be just a few months away.

So the 'UX Fund', as it was called, consisted of Apple, Google, JetBlue, Netflix, Nike, Progressive Insurance, Target, Yahoo, Blackberry and Electronic Arts. The interesting part is that there are many non-obvious entries here. Few people would put an insurance company and an airline in such a fund but they believed that these companies offered the best user experience. They actually invested $5000 in each of the ten companies, buying the shares in November 2006.

Ten years later, the $50,000 had grown to $305,926, a gain vastly exceeding any index over the period. You would think that Apple would be the big driver of the returns, but actually the star was Netflix. The $5000 in Apple grew to $44,000, a huge gain, but Netflix grew to $152,000, accounting for 60% of the total gains. Incidentally, the Nike stock made almost as much money as Apple's. The obvious dud was Blackberry but every other stock was positive.

So what's the lesson here? I would say that what designers called user experience was actually a proxy for sustained customer satisfaction, and more importantly, a businesses' commitment to customer satisfaction. That means it may well predict profitability and stock performance further out into the future than conventional measures can.

In fact, after reading about the UX Fund, I looked at the list of stocks recommended by Value Research Stock Advisor service and realised that every consumer-facing company was exceptionally strong on customer satisfaction. Should investors actually start using such an indicator to select stocks? It's certainly an idea worth looking at.

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