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How The "Starbucks Effect" Could Lead To 200% Gains

 February 25, 2013 12:59 PM
 


It's easy to find companies that have returned billions to shareholders in the past. And it's easy to find companies that dominate their markets right now.

But the future is much less certain.

As a long-term investor, how can you know your investments will continue to dominate the competition for years to come? How can you make sure they won't crumble under the weight of new competition, intense regulation, disruptive new technologies or a host of other potential problems?

Although there's no single answer to those questions, one of the most important factors to look at is customer retention.

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Companies that retain their customers for a long period of time are much more likely to deliver consistent, outsized profits for investors.

It makes perfect sense. Studies have shown that it costs seven times more to acquire a new customer than it does to keep an existing one. And existing customers are several hundred percent more likely to buy when compared with new prospects.

Businesses that enjoy strong customer loyalty also have an easier time raising their prices, which can lead to fat profit margins and strong dividend payments.

Customer loyalty comes in many forms. Sometimes a company's customers are locked in under long-term contracts. In other cases customers face significant switching costs... or they're extremely loyal to their favorite brands.

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Whatever the reason, if you invest exclusively in companies that keep their customers happy -- and keep them buying for years... decades... even for a lifetime -- then you'll increase your odds of beating the market.

Take payroll processor Automatic Data Processing (NYSE: ADP), for example. ADP is the nation's largest provider of outsourced human resources (HR) services, including payroll and benefits processing. In this niche market, it's time-consuming and expensive for large companies to switch to a different provider. In addition, ADP locks many of its customers into long-term contracts. As a result, the average client stays with ADP for more than a decade.

We use ADP to process our payroll here at StreetAuthority, so we have direct experience with the company. And I recently asked our resident accounting and HR expert in our Maryland office, Pam, for her opinion. Her comments speak volumes about why ADP retains its customers for so long...

"I am satisfied with ADP. I have used a couple of other companies over the years and always end up back with ADP when I can. They are reliable and consistent. Plus, once I get used to using a certain software package that works well, I resist change as long as possible. If it's not broke, don't fix it. I have no reason to want to change at this time."

Or how about Starbucks (Nasdaq: SBUX)

The Seattle-based chain is well known for satisfying the needsof coffee fiends the world over -- and it does an excellent job of customer retention.

The average Starbucks customer visits one of the coffee giant's 18,000 stores about six times a month, and its most loyal customers visit 16 times a month. Coffee is a convenience and location-based business. And thanks to its huge store count, Starbucks is an extremely convenient choice for most Americans -- and increasingly the rest of the world.

Its customers are also fanatical about their beverages. They stay loyal to Starbucks for the brand, the customer experience, and most important, the consistency of the company's drinks. Thanks to these factors, some analysts have estimated Starbucks retains its average customer for roughly 20 years.

Not convinced that superior customer retention leads to big gains for investors?

Just take a look at how both of these stocks have performed in recent years...

And the numbers are even stronger when you look at a longer time horizon. For example, shares of Starbucks have soared 392.6% during the past decade. Meanwhile, ADP has also handily beaten the market, gaining 130.8% in the same period. (All figures above include reinvested dividends.)

Action to Take --> If you want a shot at total returns of up to 200% in five years, then run this one simple test on all of your portfolio holdings:find out how long they retain their average customer. If the answer is a decade or more, then you're probably on the right track.

(Note: Recently, I've discovered 13 stocks with great customer loyalty and enormous "Dividend Vaults." Right now, U.S. companies are sitting on a "Dividend Vault" worth over $1.7 trillion. To learn more, including the names and ticker symbols of some of my favorite "Dividend Vault" stocks, click here.)

-- Paul Tracy

Paul Tracy owns shares of SBUX.StreetAuthority LLC owns shares of SBUX, ADP in one or more of its "real money" portfolios.
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