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A Powerful Stock-Price Predictor

Exhaustive research shows that profit and revenue don’t actually predict stock price, but some other, little-used metrics do.

A new study provides perhaps the strongest evidence to date that certain human-capital metrics can predict a company’s performance in the stock markets.

The research was nothing if not robust. Through extensive use of regression analysis, it tested the relationships between a set of human-capital metrics and stock-price movements at 22,100 companies over a 16-year period, 1996 through 2011.

A key finding of the study – performed by Jeff Higgins, CEO of the Human Capital Management Institute, and Pepperdine University professor Donald Atwater – may surprise investors, stock analysts and finance executives themselves.

Generally speaking, a company’s net income and to a lesser extent revenue are considered the gold standards for shaping expectations of its stock’s future performance. But the research found net income per full-time-equivalent employee (FTE) and net revenue per FTE – both commonly used financial metrics – to be the poorest predictors among the studied human-capital metrics. In fact, both are statistically insignificant, as is pure net profit without association with any human-capital metrics.

Instead, two metrics used by some human-capital analysts, but few other people, are powerful predictors of stock price, the research found. One, called “Return on Human Capital Investment” (Return on HCI), compares “Total Cost of Workforce” (TCOW) to net operating profit. (TCOW includes: all direct and indirect cash or equity compensation for employees and contingent workers; paid employee benefits, perks and rewards; retirement-related costs for both current and former employees; and costs for worker training, recruiting, employee relations, and severance and legal settlements.)

The other highly predictive metric is “Human Capital ROI Ratio.” It measures the ratio of return on revenue (net of non-workforce expenses) to TCOW. For example, say a company has $1 billion in revenue and $800 million in total expenses, $500 million of which are people costs. To arrive at HC ROI ratio, subtract the $300 million nonpeople costs from revenue, leaving $700 million, and divide that by the $500 million in people costs.

In essence, the two metrics are different ways of measuring the percentage return on $1 invested in the work force, assuming all other factors remain constant. In the above example for Human Capital ROI Ratio, the result is expressed as 1.40, or a 40-cents positive return on the invested dollar.

Less predictive than those two metrics, but still statistically significant, are TCOW as a percentage of operating expenses and as a percentage of revenue.

“Everyone thinks net profit drives stock price,” says Higgins, a former CFO, “and in my old finance world I thought so too. But what really drives stock price is productivity. Some might say Return on HCI and Human Capital ROI Ratio are synthetic profit metrics, but we see them as productivity metrics – the return on people’s productivity. And when those numbers improve, your stock price jumps.”

The study results are expressed in statistical language that’s generally inscrutable to those who aren’t academics or statisticians, and for the most part are given industry by industry rather than in the aggregate. At CFO’s request, the authors provided some numbers quantifying the predictive power of human-capital metrics in more accessible terms.

9 thoughts on “A Powerful Stock-Price Predictor

  1. The results of the research confirm the correctness and validity of Karl Marx’s economic theory and the ultimate justification of the entire system of economics as outlined in his “Capital”.

    • That’s quite a leap, isn’t it? Productivity drives stock prices but doesn’t necessarily mean that productivity is what gives stock value. Value is what the market says it is… I’m still with von Mises on this one.

  2. I believe “Everyone thinks net profit drives stock price” is the basic key decision to invest (price does not go down) and it is the basic fundamental rational to indicate price increment with time. If the price keeps on going either up or down, it is then the human factor that drives the price beyond the basic facts.

  3. i think productivity and profitability are not separate. but how can we predict? we cannot because companies only tell they are in dire straits after the fact when it is already too late. so win some and lose some is the rule.

  4. i think productivity and profitability are not separate. but how can we predict? we cannot because companies only tell they are in dire straits after the fact when it is already too late. so win some and lose some is the rule.

  5. I am a little confused. These “two” indicators appear to be not much different…
    HC ROI =
    = (revenue – other costs)/TCOW
    = (revenue – total costs + TCOW)/TCOW
    = (net profit + TCOW)/TCOW
    = net profit / TCOW + 1
    = Return on HCI + 1

  6. Very interesting insights… I’d, however, like to see a wider research. This one may suffer from winner’s bias i.e. if we included companies that collapsed, is the outcome consistent with the argument?

  7. So basically they are saying, that keeping the cost of your workforce low is good for a company and the price of its stocks. Not really earth shattering insight.


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