Sunday, April 24, 2011

How Investors Can Profit From Better Corporate Decisions

Companies that make so-called data-driven decisions do better than those that choose based solely on gut feel. Thus it stands to reason that those data-driven-deciders could be good investment candidates. Read on for an analysis of the investment potential of four data-driven corporate decision-makers. 

Data-driven corporate decisions use specific decision criteria and gather data to help weigh those factors and arrive at a conclusion about what to do. Having taught Strategic Decision Making to Babson College undergraduates for the last six years, I am familiar with how rare it is for companies to make data-driven decisions. According to a paper from a trio of researchers including Erik Brynjolfsson of MIT, the few companies that actually make data-driven decisions are between 5% and 6% more productive than their peers.

Why do data-driven decision-makers outperform their peers? I'd guess that the data keeps them from making bad bets that their more intuitive peers would jump into feet first. In my consulting work, I have often found that gathering data about a potential market opportunity yields insights that turn what looked like a money-making opportunity into a pit of quicksand. Such data helps companies avoid money-losing investments.

Finding companies that make data-driven decisions is not difficult. After all, International Business Machines (IBM) expects by 2015 to generate $16 billion in revenues selling analytical software that companies use to make such decisions. As it turns out, there are several publicly-traded companies more than happy to brag about their use of analytical software and each of them is worth considering as an investment.

Here are four that use IBM's analytical software to boost productivity:
A company's use of analytics to make decisions does not automatically mean it's a great investment. But it does suggest that its management brings considerable intellectual horsepower to its decision-making which the MIT researchers argue will boost their productivity above that of their peers.

For now, however, the evidence is thin that these companies have already achieved stock-market-moving superior performance as a result of their data-driven decision-making -- especially since these companies are at an early stage in their use of analytics software.

To me, it makes sense to screen these four companies based on the Price/Earnings to Growth (PEG) ratio -- a stock's Price/Earnings ratio divided by the company's earnings growth rate -- to measure whether a stock is cheap or expensive compared to its earnings growth. I think a PEG of 1.0 is fair value -- less than that and you have something of a bargain.

Using the PEG ratio, here's my ranking of the four data-driven decision-making companies:
In short, Aetna and Coca Cola are relatively inexpensive ways to play the boost in productivity that results from data-driven corporate decision-making.


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