Employment numbers have dominated the news over the past five years. Employment growth appears to be the key element now remaining for any sustained economic recovery to take root in the United States. Some companies are starting to hire more employees. Is this new hiring provide insight into future growth prospects for some companies? I decided to test this out by looking at the year-over-year percent change in the number of employees reported by the publicly traded companies in the United States.
I used the data and backtesting tool provided by Portfolio123. This backtest uses the same filtered universe of stocks as my recent market capitalization backtest. I’ve designed the filtering criteria for this backtest specifically for individual investors and with a focus on enhancing data quality. The filters include the following criteria:
- No OTC stocks. Stocks not traded on the New York Stock Exchange, NASDAQ, or American Stock Exchange markets are excluded. The quality of fundamental stock data for OTC can be somewhat lower and less timely that that for stocks traded on major exchanges.
- No ADRs. Fundamental data for foreign American Depositary Receipt can include errors due to currency exchange, different accounting standards, and share count.
- Liquidity test. The average daily total amount traded over the past 60 trading days must be larger than $100,000. This amount was selected so that a $1 million dollar portfolio could hold 100 positions and that each new $10,000 position would not exceed 10 percent of a day’s trading volume. The liquidity test also ensures that the backtest has reliable market price information for any of the stocks that are being tested.
- Market Cap > $50 million. Nano cap stocks are excluded to help improve data quality. This filter also ensures that positions in a modest sized portfolio never exceed one percent of shares outstanding or the available float for a company.
- Price > $1. True penny stocks are excluded due to various information issues and manipulation of these stocks.
- Number of Employees > 0 and Number of Employees, Prior Year >0. This filter insures we are looking at stocks that actually have data on employee numbers.
After these filters are applied, we are left with approximately 2,900 to 3,800 stocks. These are then ranked by the criteria being tested; in this case, we are testing the percent change in the number of employee from the previous year. The top 20 percent of stocks ranked by percent change in employees are placed in the first quintile and the next 20 percent in the second quintile and so forth until we have five portfolios of stocks. The portfolios are rebalanced every 12-months and compounded annually to more realistically replicate what an individual investor might be expected to do to avoid higher short-term capital gains tax and trading costs. The following 5 tables display the quintile returns for the percent change in employee growth in red and the S&P 500 Equal Weight index in blue. The first quintile includes the companies that added the highest percent increase in number employee over the prior year.
Employee Growth Quintile Returns – 2000 to 2013
Employment Growth Quintile 1 Backtest
It appears the 4th quintile best weathered the market declines in 2008. I was also surprised to see the 1st quintile underperform in almost every year. I would have thought companies that are rapidly adding employees would have strong growth prospects that would propel their stock returns. I guess that employee growth doesn’t really translate into investor returns, at least in a one year time frame. Let’s now take a closer look at the backtest numbers.
Summary of Results for the Employment Growth Fundamental
The returns for the top quintile are definitely the lowest. Returns appear to increase for considerable for the 2nd to 4th quintile and then levels off for the 5th quintile.
The data refute my original hypothesis that there might be some investment opportunities in the companies adding the most employees. In fact, the take away from this research might actually be that value investors might want to consider actively avoiding companies that are rapidly adding employees. This rapid increase comes with substantial increases in operating costs, management challenges, corporate culture shifts, and maybe overly optimistic growth expectations by management. The best investment opportunities may lie with the most stable companies that are not adding or eliminating jobs.