Trendspotting: Investing in the Happy Customer

I don’t know about you, but I gave up stock-picking based on analysis -- technical, fundamental, or astrological -- after reading that one of the most successful hedge fund managers in history made his fortune by relying entirely on a Rainman-style fascination with numbers, just raw numbers crossing the tape until he started thinking he saw patterns in the chaos, as he did often enough to make about a gazillion dollars.

But most of us probably see patterns more clearly by watching people rather than numbers in action, and common sense suggests that companies that produce things people like will prosper, while things that people hate will eventually disappear.

That’s why the American Consumer Satisfaction Index, developed at the University of Michigan’s business school, makes great reading. It tracks 45 industries that do business in the US on the basis of surveys of their customers, scoring them on a scale of zero to 100. Due to the recent turmoil in our economic system, its charts are full of little symbols like crosses, signifying RIP for some companies that didn’t make it into 2010. But since the index has been updated yearly for 16 years, you can see which companies are gaining in consumer esteem, and which ones are losing it.

The most interesting results show up in the industries that have been in the most turmoil recently, like autos.

Most recent stories about the American auto industry can be summarized, in brief, as: “Who’d a thunk it?” Nobody thought they’d actually repay those government loans, or emerge from bankruptcy, or most far-fetched of all, make a profit.

But last week we got the biggest “who’d a thunk it” of all when American automakers took the two top slots in the consumer satisfaction index for the first time in its history. Lincoln-Mercury, from Ford (F), topped the list, and Buick, from GM, was second. (Chrysler bombed, taking last place except for actually dead brands like Oldsmobile and Pontiac.)

The American brands benefited in part from the recent recalls of Japanese cars. The biggest fall in customer regard hit Toyota’s (TM) Lexus, whose owners presumably don't expect their expensive luxury cars to fail them. (The model takes into account “perceived value” relative to price, so people aren’t judging a Ford by Ferrari standards, or vice versa.)

The publishers of the index claim that it's a financial indicator and has a proven relationship to individual company performance, including corporate revenue and earnings growth as well as stock market performance.

Which ought to work out nicely even when a company stinks, as long as it stinks less than all the other companies in its sector. At least, that is, where consumer choice is limited or non-existent.

For instance:
 

• Wells Fargo (WFC): If this index was a pass/fail test, three of four of the biggest American banks would flunk consumer satisfaction. Only Wells Fargo at a score of 73 got close to the baseline score of 74. Citigroup (C) and JPMorgan Chase (JPM) each got a 68, and Bank of America (BAC) a 67. “All Others” is on top with an 80 score, suggesting that people who bank at community banks or online banks are more highly regarded by their customers, but are still too small to be measured individually.
  
  
• Southwest Airlines (LUV): The big airlines are loathed by most of their customers, but Southwest Airlines, at 79, and Continental Airlines (CAL), at 71, are loathed least. Although they’re not monopolies, airline loathsomeness probably can be traced to a lack of choice at the respondents’ nearest airports. Still, the results suggest that Southwest and Continental could grow over time at the expense of their competitors.

Some of the most interesting results are in industries where competition is fierce. There you get a sense of who’s trying harder. For example:
 

• Bing and AOL: Google (GOOG) is still at the top of the heap among Internet search engines, but its score of 80 is down a hefty 7% from last year. Meanwhile, Microsoft’s (MSFT) Bing debuts in second place at 77. And although AOL (AOL) still languishes near the bottom with a 74, that’s an improvement of 5.7% over last year and 32% over its first-year score of 56.

What better indicator of a company’s performance can you get, after all, if you believe (and devoutly hope) that companies producing things that are highly regarded by their customers will thrive, and companies whose customers hate them will die?

You can find some confirmation of that in the index, such as in Specialty Stores, where Circuit City hit the bottom of the chart in 2008 and, in 2009, got the little RIP symbol.

If customer satisfaction doesn’t work as a methodology for buying and selling stocks, I for one am going to fall back on my second-favorite method, the absurdist omens of Josh Lipton.

The full industry list for the American Consumer Satisfaction Index can be found here.