Since the dawn of earnings calls, public company CEOs have been telling investors that their employees are among their greatest assets. They were right—and now there’s proof.
Investors have struggled to quantify the connection between a public company’s human capital and its future stock performance because human capital is accounted for as an expense as the focus on tangible assets grows. Against this backdrop, identifying the impact of harder-to-measure, intangible attributes, such as the relationship between people and their company, seems to present an important alpha producing opportunity.
The evidence is building. According to Gallup, highly engaged employees result in a 23% increase in profitability. Yet despite the obvious benefits cultivated by engaged, motivated employees, the average company is apparently falling short—most of the U.S. workforce (65%) is seemingly not engaged.
The glaring question is whether engagement can be clearly identified and measured. If so, can investors measure and obtain tangible insight into a company’s human capital and its impact on future equity value?
Better Human Capital Data Drives Better Investment Outcomes
At the broadest level, a company’s human capital spans the perceptions, attitudes, behaviors, knowledge, motivations and actual experiences of its employees—from the most junior team member to the C-suite. Of course, these variables are directly shaped by how a company treats, values, manages and motivates its people.
Through the analysis of a proprietary data set—spanning more than 17 years, over 4200 public companies and more than 3.9 million survey respondents—combined with a range of public data sources, we have identified seven measurable human capital dimensions. Each one has a significant impact on a company’s long-term stock performance. The dimensions include:
Innovation—how a company embraces, encourages, and allows new and creative ideas, processes and products to flourish.
Organizational Effectiveness—how processes, cooperation and cross-organizational collaboration contribute—rather than distract—from intended outcomes.
Organizational Alignment—how closely aligned employees are to the strategy, objectives, goals, and values established by their employer.
Engagement—how connected employees are to the company’s objectives and mission. Are they taking positive actions in their day-to-day work to support the company’s reputation and broader interests?
Managerial Relationships—how employees feel about the level of support and guidance provided by their direct manager and the company’s leadership team.
Emotional Connection—employees' level of bonding on an emotional/human level with the company.
Extrinsic Motivation—how tangible rewards such as compensation, benefits, the physical environment and other easier-to-access aspects impact motivation.
Combined, these seven dimensions form a company’s Human Capital Factor (HCF), a new investment factor that’s demonstrated the ability to harness the impact a strong corporate culture has on a public company’s stock price.
Notably, JP Morgan’s Global Quantitative and Derivatives Strategy analysts compared the performance of the Human Capital Factor with that of traditional style and factor strategies (value, growth, momentum, quality) for the period of December 31, 2009 to January 31, 2021 and found, “the HCF strictly dominates all styles across all metrics, it has the highest returns, lowest volatility, highest Sharpe Ratio, highest hit-rate and lowest maximum drawdown.”
New Frontier In Factor-Based Strategies
As any of us who have worked at different companies can attest, not all corporate cultures are created equally. There is a clear (and now measurable) value-creating advantage for companies that cultivate the best from their employees by creating an environment in which trust, transparency, collaboration and equality thrive.
For investors and their advisors, the advantage derived from measuring and analyzing human capital provides an exciting new opportunity to evaluate a security and capture alpha.
David van Adelsberg is a founding partner of Irrational Capital, an investment research and development firm.