Customer-Winning Products: The Core Path to Long-Lasting Prosperity - Yahoo Finance

"I remain amazed at the number of people who talk about investment and spend most or all of their time talking about asset allocation, regional allocation, sector weightings, economic forecasts, bonds vs equities, interest rates, currencies, risk controls... but never mention the need to invest in something good."

- Terry Smith, Founder of Fundsmith

Our investable universe consists of a few dozen names that have consistently delivered a superior return on capital and that we believe will continue to do so in the future. There seem to be various approaches for different companies to achieve such a high and stable return: a high switching cost, low-cost production, brand power, a niche focus, etc. But looking at each business model, we do notice one common factor among these "wonderful businesses" - they all sell what we call "customer-winning products or services" in their respective domains.

Remember the almost impossible comeback by the then half-century-old Domino's Pizza (NYSE:DPZ) a few years ago? Back in the 2000s, Domino's Pizza was reputed for two things - quick delivery and cardboard-like taste. After listening to critiques across its customer base and realizing the seriousness of the problem, the company spent millions on developing an entirely new pizza, expanding the menu and conducting a surprising marketing strategy - it admitted that the product was awful and asked for another chance.

The result has been phenomenal. The American Customer Satisfaction Index (referred to as "ACSI") of Domino's Pizza has steadily increased from 69% in 2000 to 79% last year, roughly matching the performance at Pizza Hut and Papa John's (NASDAQ:PZZA). Over the past decade, the business consistently outperformed its peers in terms of the return on assets, which improved from under 10% to over 40% in the meantime (see below). Today, Domino's Pizza is still one of the fastest-growing quick-service restaurants in the world.

We find the ASCI benchmark a useful resource to gauge the company's ability to delight its customers over time. For example, in the search engine category, Google (NASDAQ:GOOG) (NASDAQ:GOOGL) beats Microsoft's Bing (NASDAQ:MSFT) and Verizon's Yahoo (NYSE:VZ) by a wide margin (79% vs. 72% and 70%); Costco (NASDAQ:COST) outperforms all major retailers, including Walmart's Sam's Club (NYSE:WMT) and Target (NYSE:TGT); in the airline industry, Southwest (NYSE:LUV) and Delta (DAL) are among the top achievers. Some notable underperformers at the moment include Facebook (FB) (63%), LinkedIn (69%) and McDonald's (MCD) (69%). It appears that their managers have more work to do, and shareholders should see this as an alarming sign.

Those who are interested in testing the correlation between equity return and customer satisfaction may want to look at the American Customer Satisfaction Investable Index (referred to as "ACSII"). The index utilizes customer satisfaction metrics for over 350 brands whose stocks are listed in the U.S. It weighs stocks within each sector by their relative customer satisfaction scores. As of June 30, 2019, ASCII beat the S&P 500 on a 10-year and 5-year basis but underperformed on a 3-year and 1-year basis.

Disclosure: The mention of any security in this article does not constitute an investment recommendation. Investors should always conduct careful analysis themselves or consult with their investment advisors before acting in the financial market. We own shares of Domino's Pizza and Facebook.