Do Happy Employees Make Happy Shareholders?

The debate about whether a happy workplace translates into higher stock returns has heated up lately. While traditional financial theory implies that it shouldn't, an increasing number of studies are starting to suggest otherwise. I take a look at the debate by comparing the best places to work in 2011 to their associated stock returns.

The evolution of convention
Conventional wisdom holds that the happiness of a company's employees is inversely related to its risk-adjusted stock returns. This line of thinking characterizes employees as a group of stakeholders competing for a company's coffers -- the other stakeholders being stock and bond holders. As a result, any capital allocated to employees is necessarily capital that isn't allocated to investors and creditors.

While this may be difficult for many people to accept given the state of our modern economy, it's important to remember that the role of employees has changed dramatically over the years.

A hundred years ago, consumers demanded low-cost, standardized products -- think Henry Ford's assembly line. These goods were produced domestically by unskilled laborers performing highly segmented and repetitive tasks. The threat of an employee defecting, in other words, wouldn't have been high -- their body would have simply been replaced with another after a cursory demonstration of the task at hand.

Fast-forward to today, and the situation is entirely different. According to a paper by the Federal Reserve Bank of New York, the United States lost 5 million manufacturing jobs in the period from 1976 to 2006. The share of the nation's workforce employed in that sector has accordingly dropped from 20% in 1979 to about 11% five years ago, and most likely even lower today.

Meanwhile, employment in high-skilled occupations has risen an impressive 37%, as the trappings of a modern society feed our reliance on engineers, lawyers, accountants, and doctors, as well as other types of skilled professional workers. With this shift in mind, it wouldn't be surprising to see conventional wisdom change on this count, as a smaller proportion of employees are as interchangeable as they were 100 years ago.

A crack in convention
In the last few years, a slew of studies has begun chipping away at the notion that employee happiness is antithetical to investor returns. A 2010 report by Hewitt Associates found that companies with high levels of engagement (65% or greater) outperformed the total stock market index and posted shareholder returns 19% higher than the average in 2009. Companies with disinterested employees, on the other hand (40% or less engagement), had a total shareholder return that was 44% lower than the broader market.

Similar results were reported by a Wharton professor in a 2008 paper titled "Does the Stock Market Fully Value Intangibles? Employee Satisfaction and Equity Prices." In this study, author Alex Edmans used a value-weighted portfolio of Fortune magazine's list of the best companies to work for in America in 1998. By the end of 2005, this portfolio earned over twice the market return while also outperforming industry benchmarks.

With this in mind, I decided to examine the stock returns of the top 10 companies identified by CareerBliss.com in its list of 2011's happiest companies in America. These rankings were based on more than 100,000 employee reviews that rated their workplaces on factors like work-life balance, relationships with bosses and co-workers, compensation, growth opportunities, a company's culture, and the freedom of employees to exert control over their daily work flow.

The results were not entirely consistent with the studies mentioned above. While the S&P 500 returned 0.85% in 2011, the average stock in the table below suffered a loss of 3.48% for the year. A look at some of the specific companies on the list illustrates this point. On one hand, semiconductor and software designer LSI (NYSE: LSI  ) was sixth on the list but produced a negative return for the year. On the other hand, global telecommunication company Qualcomm (Nasdaq: QCOM  ) was fourth on the list but produced double-digit returns.

Two of the more interesting companies from an employment perspective are 3M (NYSE: MMM  ) and Google (Nasdaq: GOOG  ) . The former embraces a "Bootlegging Policy" that allows employees to spend 15% of their time working on their own ideas, leading to innovations like Post-it Notes and Scotch Pop-Up Tape. And Google gives its employees "20 percent time" -- basically the same idea, but they get more time to pursue their own interests.

Rank

Company

Average Salary

2011 Stock Return

1 Google $73,946 6.8%
2 3M $76,029 (3.3%)
3 DTE Energy $64,482 25.3%
4 Qualcomm $81,221 10.7%
5 U.S. Military $45,448 N/A
6 LSI $80,200 (1.9%)
7 Charles Schwab $72,897 (34.6%)
8 PricewaterhouseCoopers $76,734 N/A
9 TRW Automotive Holdings $64,120 (39%)
10 Johnson & Johnson $81,814 8.2%

Source: Ranking and average salary from CareerBliss.com, stock returns calculated with buyupside.com's stock return calculator. N/A = not available.

Foolish bottom line
With the preceding discussion in mind, it seems safe to say that the debate about the influence of employee engagement on stock returns is likely to continue. At this point, in turn, investors would be well advised to stay focused on company financials and fundamentals.

If you're on the hunt for stock ideas, take note: Motley Fool analysts recently identified three companies set to take emerging markets by storm. The new report, "3 American Companies Set to Dominate the World," is available for free right now.

Fool contributing writer John Maxfield does not have a financial stake in any of the securities mentioned in this article. The Motley Fool owns shares of Qualcomm and Google and has sold shares of SPDR S&P 500 short. Motley Fool newsletter services have recommended buying shares of 3M and Google, as well as creating a diagonal call position in 3M. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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