A question for investors: just how important is a company’s reputation to future stock returns?
The question of reputational damage is a topical one at the moment, with investors and analysts fretting over whether Ryanair will end up paying a long-term price over its decision to cancel more than 2,000 flights due to issues with its pilot rostering.
Earlier this summer Ryanair's chief marketing officer, Kenny Jacobs, said Ryanair wanted to be seen as a "functional" brand, one that was trusted by consumers and seen as "brutally efficient, awesome on price". No one would describe the events of recent weeks as "brutally efficient".
Chief executive Michael O’Leary was typically blunt in his assessment. “We f***ed up here, and we have to fix it,” said O’Leary. “We should have seen it coming. This will have a reputational impact.” O’Leary was not always so concerned about reputational matters.
"Are we going to say sorry for our lack of customer service?" he once asked. "Absolutely not." By 2013, however, it was becoming clear not all publicity is good publicity. A Which? magazine survey of more than 3,000 people found that Ryanair was seen as having the worst customer service among the UK's 100 biggest brands.
Shortly afterwards Ryanair announced a profit warning – its second in as many months. O’Leary decided it was time to “stop unnecessarily pissing people off”.
In 2014 Ryanair launched its Always Getting Better programme. A revamped website; faster boarding for business travellers; fully allocated seating that meant there was no longer an unseemly rush for seats; allowing customers to bring on a second small carry-on bag; advertisements featuring smiling Ryanair staff – it became clear the new Ryanair was meant to be a friendlier place. And it worked. By 2015 O’Leary was able to joke: “If I’d only learned in college that being nice was good for business, I’d have done it years ago.”
Profits have soared since 2013. The share price has more than tripled. In August, Ryanair’s load factor – a measure of how much it is able to fill its aircraft with paying passengers – hit 97 per cent. For customers, however, there is nothing “nice” about having hundreds of thousands of bookings cancelled at short notice. The 98 per cent of passengers unaffected by the cancellations but left on tenterhooks for confirmation that their flights were unaffected were similarly unimpressed.
“It is the potential for long-term damage that concerns us,” cautioned RBC Capital Markets in a recent note. If the airline is seen as “unreliable and less punctual”, it could deter future bookings and put off the time-sensitive business community.
Common sense?
Concerns about a company’s reputation seem reasonable. After all, “common sense dictates it is better to have satisfied loyal customers than to have dissatisfied defecting customers”, as David Vanamburg of the American Customer Satisfaction Index noted in 2013.
Furthermore, it's easy to call to mind companies that suffered major share price declines in the wake of reputation-damaging scandals. Consider BP's 2010 oil spill in the Gulf of Mexico; Toyota's shock safety recall of more than eight million cars in 2009-10; the outrage regarding the practices of Goldman Sachs during the global financial crisis, when the company was famously dubbed by Rolling Stone's Matt Taibbi as a "great vampire squid wrapped around the face of humanity".
More recently, ride-sharing company Uber bid farewell to its cofounder and chief executive Travis Kalanick after a string of controversies badly damaged the company's reputation. At the same time, the notion that companies invariably underperform in the wake of reputational hits doesn't hold up.
BP recovered by 19 per cent in the six months following a refinery fire in Texas in 2005, outperforming the market and the oil sector. Exxon Mobil outperformed in the six months following the infamous Valdez oil spill in Alaska in 1989.
Exxon has been involved in no shortage of controversies over the years, although that hasn’t prevented the oil giant from being one of the world’s most valuable companies over the past two decades.
Tobacco companies are universally despised, but they make bundles of money and the industry has historically been the top-performing stock market sector. Toyota has moved in line with the Nikkei over the past five years, more than doubling in price. Goldman Sachs has also doubled its share price over the same period, outperforming the S&P 500.
Ryanair, too, made a lot of money for its investors during the long period where it was widely reviled for its customer service, using its controversial reputation to generate publicity aplenty. Investors should be careful not to assume that bad companies are bad stocks. In one revealing study, Stocks of Admired Companies and Spurned Ones, researchers constructed two portfolios based on Fortune magazine's annual list of the US's "most admired companies" – the most admired stocks and the most despised stocks. Between 1983 and 2007, the despised portfolio outperformed the admired stocks by almost two percentage points annually. On average, the study found, increases in admiration were followed by lower returns. Other research confirms that good press is not necessarily followed by good returns. One 2011 study found that stocks rated as strong buys by analysts went on to underperform. Research also shows the most hated national stock markets have massively outperformed the most popular markets over recent decades.
Similarly, it has traditionally been much more profitable to buy stocks in low-growth countries than in high-growth countries.
Don’t ignore reputation
Often, these contrarian findings are the result of markets over-reacting to good or bad news in the short-term; if the worst fears are not realised, then punished stocks are poised to outperform. However, this doesn’t mean investors should ignore questions regarding reputation and customer satisfaction – far from it, according to the CFI Group, a customer satisfaction consultancy.
Using data from the American Customer Satisfaction Index and the UK-related National Customer Satisfaction Index, it created a stock portfolio to assess the relationship between customer satisfaction and stock returns. Between 2000 and 2012, a $100 investment in the ACSI fund would have grown to $490, compared with a slight loss for the wider S&P 500. In the UK, the NCSI portfolio returned 59 per cent between 2007 and 2011, compared with a small decline for the Ftse 100.
"Companies with highly satisfied customers generate superior returns because customer satisfaction is critical for repeat business, and that type of business is usually very profitable," said the study's co-author Dr Claes Fornell. Similarly, a study published in the Journal of Marketing, The Long-Term Stock Market Valuation of Customer Satisfaction, found that, between 1996 and 2006, it paid to invest in stocks that prioritised customer service. For investors, there are two especially important takeaways from the above-mentioned studies.
Firstly, the Journal of Marketing study finds it's not especially effective to load up on stocks with high customer satisfaction ratings; rather, it's best to buy stocks whose customer satisfaction scores are improving.
Secondly, Dr Claes Fornell has one caveat regarding his findings, namely that loyal customers “tend to be highly profitable as long as their loyalty comes from their satisfaction and not because prices are low” – a message, perhaps, that ought to be heeded by Ryanair executives in the coming months.
