3 stocks with high customer retention that have this fundie’s attention

What would cause you to no longer use the products or services of a company? A drop-off in quality? Poor service or support? A new, more compelling offering from a competitor?

Whatever it may be, these days, we all have an abundance of choice and it is not hard to change teams if we don't like the result we're getting.

The competitive landscape is changing at an incredible rate and one need only look at the likes of Airbnb, Uber, Facebook and Alibaba to see how age-old industries are being disrupted. They are monoliths in their respective spaces yet AirBnB, the world's largest accommodation provider, owns no property. Uber, the world's largest taxi service, owns no cars. Facebook owns no content. Alibaba owns no inventory. Go figure.

So how does one invest when things are changing so rapidly? Well, first and foremost, have a plan. Secondly, stick to it. And thirdly, in the case of Stephen Arnold, managing director and CIO at Aoris Investment Management, look for companies with a strong history of ridiculously high customer retention levels - particularly where the customer has a choice.

In this wire, Arnold presents three such businesses and shares two key lessons learned since launching the Aoris international Fund.

Edited transcript

Take us through your stock selection process.

Stephen Arnold: The stocks that go into our portfolio are high-quality, growing, wealth-creating businesses.

They're durable, they've been around a long time, they're time-tested, they're consistently profitable, all-weather businesses, and they're competitively winning businesses. They don't just grow with their market, they do better than that, they grow faster than their peers. And I think that's a great validation of a quality business.

And a good company to illustrate those characteristics with is L'Oreal (EPA:OR), the world's largest, global beauty company. It was founded in 1909, so it's been around for more than a hundred years. It's a business that grows faster than its peers. In fact, in 2021, it grew twice as fast as its global peer group. In the first half of 2020, in a market that grew by about 6%, L'Oreal grew by 13%. And while we're hearing all about logistics and supply chain and inflation challenges, their profit margin in the first half of 2022 was higher than it was a year ago. And so, they're the characteristics we're looking for, durability, competitively winning and growing, and consistently profitable.

What is one factor that is critical to your stock selection process?

A measure that we attach a lot of value to, but it's not talked about nearly as much as I think it should be, is customer retention rate.

We like businesses that have happy customers that stay around a long time, that would willingly pay more for the service, would love to do more business with their supplier, and would happily recommend them to somebody else.

Let me illustrate that with a few businesses.

Cintas (NASDAQ: CTAS), America's largest uniform rental company has a customer retention rate of 96%, which means customers are staying with them, on average, for more than 20 years. And customers have got choices, they could buy the uniform instead, but they choose to give it to Cintas and they stay there a long time.

For Accenture (NYSE: ACN), 98 of its top 100 customers have been customers for more than 10 years. And all of those 98 businesses are doing a lot more business with Accenture today than there were five and 10 years ago.

And the last one is Costco (NASDAQ: COST). Costco is a membership supermarket or warehouse business, you have to pay a fee shop there, but their members stay a long time. In fact, in America, their retention rate for their members is 94%.

And so, the retention rate's really valuable where customers have a choice. I remember I used to travel to America in the 1990s, particularly when I was at Platinum, and you turn on the television and cable television was the only option. It didn't get any better, but people didn't discontinue the service because they had no choice. And of course, in the last few years, people do have a choice and they leave in droves.

So customer retention, where the customer has a choice, is a really valuable metric and one we pay a lot of attention to.

Volatility creates opportunity. What has you excited right now?

We're excited about what our portfolio offers to investors today, more importantly, over a five-to-seven-year time period. But we think, today, as you said, volatility has meant things are cheaper, but it's also meant that the businesses that we own today are time-tested in a way that's really valuable.

We know how they've dealt with inflation. We know how they've dealt with labour shortages. We know how they've dealt with supply chain challenges. We can see the choices management has made in ways that have been really valuable to those businesses.

And so, it's 15 businesses we have a higher degree of confidence in that we could have two years ago through the value of that pandemic experience and they're cheaper. And so, we think that combination of quality, the value of recent experience and price, it makes it a compelling proposition for longer-term investors.

What has been your biggest learning since launching Aoris?

I might share two key lessons, the first of which is that every crisis, every recession, and every period of financial stress is different. And it's always tempting to reference back to, right now, "Oh, well, how did the world cope with inflation in the 1970s?" Well, the world is a very different place than in the 1970s. During the pandemic, the mental shortcut is to refer back to the global financial crisis, but everything about it was different.

And so, what's been a real learning for me is to not look for those mental shortcuts. Consider today's scenario on its own merits. Think independently because there are more differences in those time periods than there are commonalities.

And the second key learning for us as a business has been the value of transparency. We show every stock in our portfolio every month, but that allows us to talk to our clients about what we own and why we own them in a way that if we only showed part of the portfolio, we can't do. And we want clients to feel like they own all these businesses, and they want us to understand why. And so, transparency is unconventional, but it's been a deliberate choice and one that, through our experience at Aoris, we think has been a really good choice.

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