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Costco vs. Wal-Mart: Higher Wages Mean Superior Returns for Investors

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Whether we consider sales, earnings, or stock market returns, Costco (NASDAQ: COST  ) is outperforming Wal-Mart (NYSE: WMT  ) by a considerable margin in recent years. This is probably due to a multiplicity of factors, since both companies have important differences in areas such as business model and size.

However, there could be some important lessons to be learned from the competition between Costco and Wal-Mart when it comes to employee compensation and its relationship to business profitability. While many people tend to think that higher costs in segments such as salaries and benefits are necessarily detrimental for shareholders' returns, this interpretation may be far too shortsighted.

Over a period of years, attracting a more talented workforce and keeping employees incentivized has undeniable benefits for productivity and customer service, among many other business aspects, and this is probably one reason why Costco shareholders are receiving superior returns than investors in Wal-Mart.

Costco vs. Wal-Mart 
An investment in Costco has been far more profitable than a position in Wal-Mart in the last decade.

Source YCharts.

Costco is not only beating Wal-Mart when it comes to stock market returns, which can at times be heavily influenced by subjective factors such as investors' opinions and perceptions about different companies. Costco is also doing much better when it comes to the cold, hard numbers of sales and net income.

Source: YCharts.

Source: YCharts.

This outperformance cannot be attributed to a single factor, since there are important differences between both organizations when it comes to matters such as business model, strategy, and company size.

Costco has been a pioneer in the warehouse club retail model, and the company was materially smaller than Wal-Mart 10 years ago, so it was easier for Costco to expand more rapidly from a smaller base. However, it's worth noting that Costco and Wal-Mart have significantly different policies when it comes to salaries and other employee benefits.

Human resources
Costco understands the importance of attracting and retaining a skilled and incentivized workforce.

According to an article published last June in Bloomberg Buisnessweek, Costco pays its hourly workers an average of $20.89 per hour versus an average wage of $12.67 per hour for full-time Wal-Mart employees. The company also offers better benefits, such as health insurance and 401(k) plans, and it provides abundant opportunities for professional growth to employees at different levels.

This policy is not based solely on pure altruism; a happier workforce reduces employee turnover while increasing productivity and loyalty. Better customer service has given Costco a growing and recurrent customer base: the membership renewal rate is usually above 85%, thanks to customers who are generally quite happy with what Costco has to offer.

Wal-Mart, on the other hand, has been widely criticized for insufficient wages and poor working conditions. This is not only a problem for workers, as the company has the lowest ranking among supermarkets in the American Customer Satisfaction Index, with a score of 72 versus an industry average of 78.

It could be argued that Wal-Mart follows this strategy to provide lower prices than the competition. However, customers don´t seem to believe that this is the best way to go, at least judging by their shopping decisions lately.

The company has been delivering lackluster financial performance in recent quarters, reporting a 0.4% decline in same-store sales in Wal-Mart U.S. during the 14 weeks ended on Jan. 31. Comparable-store sales at Sam's Club locations, excluding fuel, declined by 0.1% during the period.

Costco is also being hurt by factors such as harsh weather conditions and lackluster consumer demand, but the company still reported a much better performance in its latest earnings report. Comparable-store sales increased by 5% during the 12 weeks ending Feb. 16 when excluding gasoline price fluctuations.  

Far from being reduced, the performance gap between Costco and Wal-Mart seems to be increasing, and this provides further validation for Costco's innovative strategies in human resources and other areas.

Foolish takeaway
Salaries and benefits are not only expenses on an income statement. Human talent is a valuable resource in the increasingly competitive business world. Skilled employees working under the right incentives can generate enormous benefits for investors via increased productivity and customer satisfaction, just for starters. Innovative companies such as Costco prove that happy employees can make shareholders smile, too.

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Read/Post Comments (3) | Recommend This Article (7)

Comments from our Foolish Readers

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  • Report this Comment On March 12, 2014, at 5:44 PM, cynth wrote:

    Boy, you people just are pushing costco EVERY day, aren't ya! TWICE a day! Every time, you try to more emphatically say how great costco is, in different ways, to bring up different points about how lucrative its future is, ostensibly to get people to buy buy buy with desperate exuberant urgency. What, did you sell put options before their dismal earnings report came out and you're desperately trying to get other people to buy so that they expire out of the money? It was in the 112s several times recently, not just after the earnings report, it was under 110 once or twice during the "correction" fiasco at the end of January/beginning of February, and I didn't see motley fool articles being pumped out every day THEN about how you've got to rush to buy costco stock, so what, is Costco's business model suddenly a surprise to you now? Nothing is different, except that it's 115 now. And it's likely to fall right back to the 114s or 113s as soon as you stop pumping these articles out constantly. Call me a cynic but I am indeed cynical about your motivations. It's too much. Every frigging day. It's insulting. And that's coming from someone who has 40 shares of it myself (and I'm not rich)! It reminds me of all the times I've been misled myself by people who say "buy buy buy, it's red hot right now!" It's how I got bankrupted in 2k8, listening to people who knew even less than I did. Granted I don't think it's going to fail any time soon, I wouldn't have shares myself if it did, but it's at the point where it's no longer really a growth stock, it's bordering on being a value stock now. A value stock with growth valued into it already, so that it's an expensive stock. And that extra cost in the share price could go away, all it takes is for it to fall out of favor with the masses. Look at its price to book ratio and price to earnings ratio compared to other retailers, it's much higher. You need to mention both sides of the coin if you want to even present a semblance of honesty and impartiality.

  • Report this Comment On March 13, 2014, at 11:49 AM, mdouma22 wrote:

    Costco has a "warehouse business model" where bulk goods are sold from pallets. Walmart has a more traditional model where small quantity goods are stocked on shelves—similar to most grocery stores. It takes five times as many staff to load Walmart shelves than it does Costco to load its shelves. Your comparison between the two is nonsense.

  • Report this Comment On June 03, 2014, at 8:06 PM, Silina wrote:

    Perhaps, even though Costco is a "big box" store, they realize that when you treat your employees well and with respect, the employees, in turn, treat customers well. This long ago policy is something that has been lost in the past 25 years or so with the new mantra of the MBA graduates of "do more with less," and CEO salaries and benefits being obscenely high. Not only the "do more with less" philosophy rampant but unions, which gave raises, vacations and pensions to all, not just union members, have become nearly non existent.

    Our nation, and the middle class is suffering due to these thought processes.

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Andrés Cardenal

Andres Cardenal, CFA is a tenacious researcher of the best investment opportunities around the world. Andres is an economist and CFA Charterholder living in Buenos Aires, Argentina. Naturally flavored. Follow me on Twitter for more investment ideas:

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