Finding the 84% of Stock Market Value That Most Investors Ignore

HIP Investor |

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The global economy is made up of capital in many forms. Fortune magazine’s recent annual release of the 100 Best Companies to Work For list and the annual Great Place to Work® Conference in April 2015 present opportunities for investors to better understand the wealth, capital, and asset value provided by, well, us. Milton Friedman agreed back in 1956, “Total wealth includes all sources of ‘income’. One such source is the productive capacity of human beings.”

Acknowledging All Forms of Capital

As our global and interconnected economy becomes less about physical resource capital, additional intelligence comes from understanding wealth embedded in human and environmental capital. Wired magazine’s founding editor Kevin Kelly says in his book, “the new economy deals in wispy entities such as information, relationships, copyright, entertainment, securities, and derivatives.”

Impact investors, too, recognize capital in its many forms: social capital, in the form of people and relationships, ecological capital, in the form of Earth’s natural systems and externalities of extracting resources, and intellectual capital, in the form of human knowledge and ideas.

Concurrently with the 2015 100 Best Companies to Work For unveiling, equity research firm Ocean Tomo released its latest data on intangible market value. In today’s markets, most of the equity market value is derived from assets that are not on the balance sheet, according to Ocean Tomo. For the S&P 500 equity index, 84% of the market value is “intangible” – from assets not captured on the balance sheet, like human capital – while only 16% is “tangible” – cash, receivables, plant, property, equipment, inventory, which we all learned in Accounting 101.

Today, Generally Accepted Accounting Principles (GAAP) do not properly account for these intangible assets. In economics, land, labor and capital are factors of production. While land is an asset on the balance sheet, labor is an expense. This vastly miscalculates and understates the drivers of value creation for all organizations.

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Measuring the Value of Human Capital

Without a valuation of people as assets on GAAP accounting statements, investors need to seek out their own estimates of this value. A Fortune 100 Best Company brand may alone entice companies to provide benefits that keep employees happy and healthy, but forward-looking business leaders understand the value goes beyond prestige. Engaged employees deliver their personal best, keep customers happy, stay loyal to a company over the long-term, and generally deliver consistently on business objectives. This can translate to more innovative products, higher sales, lower costs from staff turnover, and lower financial volatility.

Several methodologies can uncover companies which value employees: direct employee surveys, quantitative metrics, and qualitative factors. Great Place to Work® Institute employs its independently developed Trust Index© survey, gathering employee responses on challenges, atmosphere, rewards, pride, communication and bosses. Parnassus Endeavor Fund (PARWX) uses a combination of quantitative and qualitative information from company and 3rd party reports: respectful and fair treatment of employees, employee satisfaction and engagement, pay and benefits, family-friendly policies, and support for volunteerism and philanthropy. Other methods rely on quantitative factors that link to drivers of value creation and risk reduction, such as employee retention rates and Board diversity, which have positive linkages to total shareholder return.

 

The table below shows the different ways to measure great companies to work for:

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Global networks of talent continue to advance our economy. Though no company is perfect and no measurement system is comprehensive, these human-capital factors drive corporate value creation, and are not typically analyzed or prioritized by buy-side and sell-side analysts.

David Shanklin of Great Place to Work® writes, more than perks, what makes the 100 Best Companies list illuminating is it showcases relationships. Great Place to Work® co-founder Robert Levering studied bad workplaces for many years before studying good ones. When he and Milton Moskowitz visited great companies, they immediately saw the strong quality of relationships among employees at all levels. They got specific on what builds “relationship capital” more than any other variable:  trust.

Twenty-five years of studying places to work shows the great ones exhibit high trust, particularly in employee and manager relationships. As Fortune’s Geoff Colvin further points out, what perks serve to do is cultivate an environment of trusting relationships. This trust generally leads to stronger value creation for businesses and shareholders, as well as stability and rewards for employees.

To learn more about this potential value, Great Place to Work® encourages anyone interested to attend their annual conference next week on April 22-23. “There will be a number of great workplace leaders at our annual conference discussing the business benefits of becoming a better workplace,” says Chris Gassman of Great Place to Work® Institute.

To Invest in Good Companies, Invest in Great Companies to Work For

What Great Place to Work® captured 25 years ago to distinguish core drivers of the best workplaces, Wharton Finance professor Dr. Alex Edmans translated to the stock market. His landmark academic research showed that the “spirit of trust” Levering and Moskowitz found is also brought to light in long-term stock performance.

Dr. Edmans demonstrated over a 25 year period from 1984 to 2009, the “100 Best Companies” list resulted in annualized risk-adjusted return (alpha) of +3.5% per year against the total market. Great Place to Work® and Russell Investments track investment performance since Fortune magazine began publishing the list in 1998. Even with the increased profile of the 100 Best Companies from Fortune, the outperformance continues, as shown in the graph below, meaning that investors and traders are not incorporating these signals into the market price.

 

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Source: Great Place to Work® Institute, Russell Investments

The table following shows a selection of investment funds or indexes which invest in great workplaces using employee surveys, quantitative metrics, qualitative factors, or a combination.

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Note 1 – Parnassus Endeavor Fund performance inception date as of April 29, 2005. HIP Best Companies to Work For Index performance inception date June 27, 2013. HIP Best Companies to Work For Index  annual alpha calculation over 21 month period. S&P 500 Index performance from Morningstar and inception date as of January 30, 1970. Figures beyond one year are annualized. HIP Best Companies to Work For Index figures are unaudited. Indexes are NOT investable. Please read all the disclosures and disclaimers at the bottom of this post.

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Dr. Edmans, now at London Business School, expanded his earlier 2010 research at Wharton and found the United States results consistent with 14 countries across the globe. His 2014 academic paper, “Employee Satisfaction, Labor Market Flexibility, and Stock Returns Around The World,” reinforces the positive nature of human-capital on shareholder value and risk reduction.

Impact investors can appreciate Great Place to Work® Institute’s driving mission: “Building a better society by helping companies to transform their workplaces.” Company leaders can learn how to attract impact investors through the Great Place to Work® annual conference, taking place this year in Dallas, Texas on April 22-23, 2015.

The opportunity to transform society through mutual care and trust in our workplaces, strengthen investment portfolios, and more effectively allocate capital in the marketplace, is consistent with a bottom-line approach – one that benefits people as well as shareholder profit.

How do you approach people as well as profit in your investment portfolio? Please share your commentary and suggestions in the comments section below.

 

By Shilpa Andalkar

 

Shilpa Andalkar is Senior Vice President and an investment adviser representative (Series 65) of HIP Investor Inc. and HIP Investor Ratings LLC (More info at http://www.HIPinvestor.com)

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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