A lesson on wages from Ford and Fortune

On the International Small-Mid Company team, we continually test assumptions and challenge conventional wisdom. Two areas in particular have attracted our scrutiny over the past few months. The first is the persistent effect of employee satisfaction as a driver of share price outperformance, despite the fact that it was identified as such long ago. The second is a hot topic of late: wages and their effect on shareholder returns.

Why employee satisfaction matters

One commonly held assumption in equity investing is that all market anomalies are quickly arbitraged away once they have been described in market literature. But this is not the case. Not all outperformance indicators lose their oomph over time. Employee satisfaction is a case in point. It is one of the most effective indicators of future outperformance and has remained persistent. 

Employee satisfaction as a predictor of future share price outperformance was identified in 2011 in an article published by The Journal of Financial Economics. In it, the author demonstrated that from 1989 through 2008, employee satisfaction, as evidenced by a company’s being named to the list of “100 Best Companies to Work for in America,” correlated with a  higher return for its shareholders than its industry benchmark.¹

Given that it has been 10 years since this article was published, and that the list of “100 Best Companies to Work for in America” is published every year by Fortune magazine, one would expect the advantage to have been priced in by now. In other words, you might expect enterprising investors to target this list every year and quickly bid up the valuations of these companies. But that has not been the case.

Wages: A key factor of employee satisfaction

The second, related, assumption we’ve pondered as of late is the impact of higher wages. Conventional wisdom holds that higher employee wages are bad for companies, their margins, their bottom line, and shareholder returns. But we take issue with that assumption. In our view, wages are a key factor of employee satisfaction. And we already know that employee satisfaction has been correlated  positively with share price outperformance over time.

This correlation — between employee satisfaction and share price outperformance — should not be surprising. After all, a motivated, low-churn workforce is likely to compound value-add for a company versus an under-committed or under-compensated workforce that wishes it were working elsewhere.

Henry Ford recognized the advantages of taking care of employees all the way back in 1914. He famously doubled the wages of his workforce from $2.34 to $5.00 per day.² As he said at the time to a Saturday Evening Post reporter, “If the floor sweeper’s heart is in his job he can save us five dollars a day by picking up small tools instead of sweeping them out.” ²

In today’s knowledge economy, employee buy-in has led to considerable operational efficiency, with even greater benefits to the bottom line. Among the key employees in our investments are those working in sales, and we prefer direct salesforces in our holdings given their power to solidify the all-important customer-relationship. 

How we assess employee satisfaction

As part of the multi-stakeholder research process for Invesco International Small-Mid Cap Fund, employee satisfaction and churn play an integral role in our evaluation. As fundamental investors, we embark on this multi-stakeholder research process by looking at a company’s owners and senior managers, as well as the company’s relationships with other key stakeholders, such as employees, suppliers, customers, and so forth.

Rather than focus unduly on the shareholder as the only meaningful stakeholder (as conventional wisdom would advocate), our more holistic approach incorporates the four key stakeholder groups of our companies: shareholders, customers, suppliers, and of course employees.  Companies which delight their customers and retain healthy as well as productive relations with their suppliers and employees may delight their shareholders over time. 

With the International Small-Mid Company Fund’s focus on businesses which are asset-light and highly profitable, employee satisfaction and retention may  make all the difference. In today’s climate where labor costs are more volatile and upwardly biased, we feel better prepared to assess these costs to evaluate their future effect on earnings and shareholder value creation.