The Secret Tool I Use to Beat the Market

More than four years ago, I had decided on the stock I was going to buy: BofI Holdings, known today as Axos Financial. The bank was growing fast and had a differentiated branchless model. But before I hit "Buy," I had to check one last source.

That only took ten minutes, but once I was done, I changed my mind entirely. There was enough uncertainty about the culture at the company -- the real-world (read: not abstract Wall Street jargon) experience of the people doing the hard work to build an organization -- to give me pause.

I was lucky I did. Over the ensuing five months, the stock would lose 60% of its value. The culprit: a suit brought on by a former employee.

Image source: Getty Images.

That key source was Glassdoor.com -- a website where current and former employees of companies can leave reviews for the world to see. As you'll see below, Glassdoor's platform is far from perfect. And the fact that I avoided a big loser at just the right time was equally due to luck.

But if investors can learn how to mine Glassdoor for the right kind of knowledge, it can be a valuable data point.

Proof is in the pudding

Starting in January 2009, Glassdoor has published the top companies to work for in the nation. I wanted to see if publicly traded companies on the list significantly outperformed the market.

I went back and included every company (from 2009 until 2015) in the Top Ten that were publicly traded at the time and still are. I then calculated the five-year returns of each stock, and compared them to the market. The results speak for themselves.

Data source: Glassdoor.com, YCharts, author's calculations. All returns include dividends reinvested. Percentages rounded to nearest whole number

These are not insignificant differences. Sure, there are losers -- like 2010's inclusion of Juniper Networks, which under-performed the market by 120 percentage points. But they were more than balanced out by winners like Netflix in 2009 -- which returned over 1,100% in the ensuing five years.

Here's the problem: the list only comes out once per year -- and most investors are regularly putting money into the market. The list provides an interesting proxy for validating Glassdoor as a source -- but the list alone isn't what's useful.

Instead, I like to use Glassdoor as a negative indicator. Culture is just one of many factors you need to investigate. There are thousands of companies to put your money into. Instead of using Glassdoor to add to the list, I find it helpful in paring things down.

Here's what you need to look at.

Critical factor 1: Volume of reviews

Anyone who has studied statistics knows that sample size matters. While Glassdoor is far from scientifically sound -- it has self-selecting participation -- you only want to pick companies that have at least 100 reviews (though the more, the better).

This is especially important to consider when evaluating small cap stocks or international stocks. Such companies often don't have a critical mass of employees logging onto the site -- and the value of those reviews is minimal.

Take Chinese gaming company Bilibili as an example. Employees give it high marks (4.3 stars out of 5.0), with 100% saying they'd recommend it to a friend. The number of reviews: six. In the end, this data point means nothing. 

Critical factor 2: Detecting odd patterns (especially in positive reviews)

Here's where the real sleuthing begins. The best part about Glassdoor is that it's anonymous: unhappy (or happy) employees can post honest reviews without fear of retribution. But that's also the worst part about it. Because reviews are anonymous, the system can be gamed.

That requires you to dive a little deeper. The most important thing: Look for patterns in how the reviews are made. For instance, are all of the reviews clustered around the same few days? Then you're probably looking at either HR (for positive reviews) or short-seller (for negative reviews) manipulation.

I was recently looking at buying Anaplan (PLAN) for my family's own portfolio. On the surface, things look good: 3.7 stars, with 88% approval rating for the CEO.

But when I dug deeper, I noticed troubling patterns. They included:

• There were 24 reviews (10% of all reviews at the time) in a one-week period at the end of 2018. All gave the company five stars. All were sparse on details. This is an obvious sign of a company asking employees to give positive reviews. It dilutes the value of this data point.
• The reviews started taking a decidedly negative tone following this one-week period. Since Mar. 11, 2019, management hasn't offered any responses to reviews. Given that the company went public in late 2018, it makes me wonder if this was simply a ruse to help the IPO.

Anaplan may very well go on to be a great company and stock. But given the data available to me via Glassdoor, I'm keeping it in the "Not Right Now" pile for my own portfolio.

Critical factor 3: How detailed are the reviews -- especially the negative ones?

Finally, it's worth really reading the reviews. If they all cover the same bullet points, they are likely not genuine. 

But the real value lies in mining the negative reviews. Surely, from time to time, disgruntled employees will simply nag on toxic culture and incompetent leadership. Sometimes, however, there are valuable nuggets included.

In early 2016, I discovered troubling reviews for organic-goods conglomerate Hain Celestial (HAIN 0.31%). A few in particular stood out. They detailed how the company was simply buying up popular small brands, milking them for all they were worth, and then leaving them to die. This lent big short-term boost to the stock, but such boosts simply weren't sustainable.

The results since I sold: It is losing to the S&P 500 by over 100 percentage points!

Remember, this is just one data point

But beware: Glassdoor is not a panacea. In my own investing framework, it is one of eight factors I investigate, and it gets the least weight of all of them. 

That said, it can be an important factor in eliminating toxic companies from your portfolio. Next time you think you've found the right stock, be sure to jump on Glassdoor and dig around. Ten minutes could make an enormous difference to your financial future.