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Do Good Employers Make Good Investments?

Posted in Fundamental Valuation

Do companies famously known as good places to work outperform as investments? Or, contrarily, do they waste resources keeping employees happy? In his May 2007 paper entitled “Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices”, Alex Edmans analyzes the relationship between employee satisfaction and long-term stock performance. He identifies companies with exceptionally satisfied employees via Fortune magazine’s annual list of the “100 Best Companies to Work for in America.” Using these lists for 1998-2005 and monthly stock price data for the publicly traded companies in the lists (about 60 per year), he finds that:

  • A portfolio of the “best employers” of January 1998 generates an average annual return of 14% through 2005, more than doubling the market return. This portfolio outperforms industry-matched and characteristics-matched benchmarks. It yields a monthly four-factor (adjusting for market returns, size, value and momentum) alpha of 0.7%.
  • When the portfolio contains only companies from the top 50 “best employers,” the average annual return is 17.3% and the monthly four-factor alpha is 0.9%.
  • Investing in employee satisfaction apparently pays off eventually in terms of market valuation.
  • Investors do not fully price this intangible over the short term, despite its public measurement.

The following table, taken from the paper, summarizes the average excess monthly returns for four portfolios:

  • Portfolio I contains the current equally-weighted publicly traded “best employers”, reformed each February 1 during 1998-2005.
  • Portfolio II simply calculates the returns to the original 64 “best employers” of 1998 during 1998-2005.
  • Portfolio III augments the original 64 companies with new companies from subsequent lists, but it does not drop any companies falling off the list.
  • Portfolio IV contains only companies dropped from the list during 1999-2005.

The table shows the excess returns over a broad capitalization-weighted index, a benchmark portfolio assembled from the industries represented in the “best employers” portfolios and a benchmark portfolio assembled to match the size, book-to-market and momentum characteristics of the “best employers” portfolios. All “best employers” portfolios outperform all benchmarks.

In summary, the (Fortune magazine) best places to work make on average good long-term investments.

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