Stocks Leading Indicators 🔮
expanding research beyond financials
Financials are always lagging.
The idea is simple: if a business does well, financials eventually improve. A good Return on Capital or Operating Margin will be the inevitable consequence of profitable, successful business decisions.
We as investor tend to reaseach stocks using screeners and financial KPIs. And that’s totally okay. However, using financial only would in my opinion provide a partial view on the potential of a stock.
Are there signals, leading factors that can help us anticipate how financials will look like in the future? Well, it’s a complicated subject but here today I try to list some.
Ideas for leading indicators
Brand Value
“In the long-term, there is no misalignment between customer success and shareholder success” (J.Bezos, 1999).
Brand Value is a reflection of the popularity, demand and appreciation of end customers. A growing brand value might be hinting several positive things: higher products/services adoption, higher perceived value, higher switching costs & pricing power.
That’s why I always keep an eye on global brands rankings, paying attention to what brands increase or decrease in value over time.
Check out my latest Instagram post here:
Founder still CEO
In this study from Schroders, it emerged how founder-led companies outperformed the rest across several factors:
Founders tend to be more aggressive on innovation and infrastructure spending. They are not scared to sacrifice short-term profits to achive long-term competitive advantage.
Vice-versa, a CEO with a 3-year mandate might be more inclined to chase short-term wins instead of committing for a future where he may not include him/her in the picture.
Innovation Spending
Wall Street loves innovative stocks. Meaning businesses that lead the way of new technological cycles.
Provided that we don’t have to find the next OpenAI (if there’s one), how can we know if a company is in the frontline of technological development? My simple take: just look at Research & Development expenditure over Sales.
I like stocks with an R&D/Sales ratio above 10%.
My next goal would be then to understand where those investments are going, what innovations are on the pipeline, and so on. Difficult, but fun job.
Blue Ocean Sectors
What differentiates a blue ocean from a red ocean sector?
Usually, blue ocean industries have the following characteristics: new or rapidly growing industries, sectors with medium-high operating margins, where multiple winners can coexist.
Examples: SaaS, Advertising, Online Education, Soft Drinks.
A red ocean sector typically refers to low-margin businesses where the market is mature and competition is based on price rather than value.
Examples: shopping retail, retail banks, telecommunications, streaming services.
Moral of the story: let the odds be in your favor and avoid red oceans. Look out for great, blue ocean businesses.
Proven M&A Track Record
Mature businesses might not have the flexibility to grow organically as much as they did in the past. What they may have, however, is the cash flow to buy rising stars.
That’s the story both of Microsoft and Meta, two mega-caps that built their long-lasting success on successful, visionary acquisition deals.
Instagram, WhatsApp, Oculus: Meta is a great example on M&A compounder.
LinkedIn, Skype, Activision Blizzard, and the list may continue forever. Microsoft has the largest market capitalization in the world for one reason: the unparalleled ability to acquire businesses in a well-diversified ecosystem.
Net Promoter Score
Last point especially valid for B2C businesses: NPS.
This is a score that highlights if customers are happy about a certain product or service. Stats for individual companies are available online.
Values higher than 50 signal a beloved product or service. Values below 30 hint the opposite.
CostCo has the highest NPS among US retailers.
The art of searching leading indicators will remain what it is… an art. Finding scientific correlation between the points of today’s post and a stock return is a complicated mission.
That being said, I have been using these criteria for my personal research and equity selection and I find them useful both to avoid excessive risk and find superior businesses.
Is this working? Yes, but only time will tell!
Thank you so much for your valuable time.
Happy Investing,
Francesco - Business Invest