It's the Employees, Stupid

I'm no Albert Einstein, a fact many readers like to remind me of. But I just do not understand people's logic sometimes. In last Friday's USA Today, two Wall Street analysts questioned whether Costco (NASDAQ:COST), a Motley Fool Stock Advisor recommendation, treats its employees and its customers better than its shareholders.

If it's true, then we should see evidence of the shareholders getting the short end of the stick. So I'll challenge the rhetoric by looking at SGA/Sales, operating margins, Foolish Flow ratios, and price-to-book ratios. And we'll compare the ratios to competitor BJ's Wholesale (NYSE:BJ), as Wal-Mart (NYSE:WMT) does not break out enough detail about Sam's Club to make a full comparison.

The SGA/Sales ratios give evidence of Costco's above-average wages. But we cannot look at SGA/Sales without looking at operating margins, as there are other ways Costco can save money. And from the operating margins, we see that Costco generates more EBIT than BJ's. Seems like shareholders are really getting the shaft.

The Foolish Flow ratios give additional insights. Notice that Costco's Foolish Flow ratio is 30% lower than BJ's. That means Costco manages its working capital significantly better than BJ's does (don't forget that Costco is more than five times the size of BJ's). And in retailing, that's the name of the game -- productivity! Man, shareholders took it on the chin there.

Although price-to-book ratios are not an economic measure, they do give us an idea about what the market thinks. The market considers Costco's assets to be more valuable that BJ's assets. Assets are valuable when people such as, I don't know, employees extract returns from them.

CEO James Sinegal is correct in realizing incentives are a power thing. Herb Kelleher realized this at Southwest Airlines (NYSE:LUV). Ken Iverson and Arthur Blank realized this at Nucor Steel (NYSE:NUE) and Home Depot (NYSE:HD), respectively. Charlie Munger realizes this. Heck, the growth of the American economy is almost entirely based on productivity.

If I were a shareholder, I would be glad Sinegal is sticking to his guns. He caps the markups to make sure every employee "gets it." He pays them well to make sure costs stay low, customers stay happy, and shareholders see returns. If you take away the incentives, you take away the results. For in the game of productivity in retailing, to borrow a line from James Carville, it's the employees, stupid.

Wonder which other companies sit alongside Costco in Tom Gardner's list of recommended investments? Subscribe to Motley Fool Stock Advisor today with a six-month money-back guarantee.

Fool contributor David Meier does not own shares in any of the companies mentioned.