2 Reasons Why Walmarts Massive Wage Increase Is Smart

By Markets Fool.com

Continue Reading Below

On Thursday, Feb. 19, megaretailer Walmart shocked analysts, investors, and employees alike when they announced pay raises for a massive 500,000 workers -- starting with a pay increase to $9 per hour effective April, and increasing to $10 per hour by February 2016. While many low-wage employees celebrated, Wall Street seemed less enthused, sending the stock down more than 3% on the news.

However, in a classic case of Wall Street's next quarter-focused myopia, short-term traders and scalpers seem to be missing the greater point: Happy employees make for happy investors. Fortunately for long-term investors, short-term overreaction -- in this case, reactionary and politically driven -- can make for good entry points if you have a buy thesis on the company.

Here are two reasons why Walmart's wage increase is smart.

No. 1: This puts pricing pressure on other retailers
Although Walmart is often seen as the face of the low-wage employer, it isn't the only one. As a matter of fact, most retailing jobs are low/minimum-wage jobs. Considering that many minimum-wage jobs are interchangeable in terms of skills, Walmart has essentially accomplished what President Obama hasn't been able to do -- the company has instituted a de facto minimum wage increase of $10 per hour by 2016, only $0.10 lower than the administration's goal.

Specifically, the economics of the increase are interesting when you consider the labor markets. By raising the wage, Walmart instantly becomes the employer of choice among the low-wage set. If other retailers fail to match Walmart's wages, Walmart gets its pick of talent from the low-cost set. And while many on Wall Street treat labor as just another input, on a long-term basis, talented employees are a source of competitive advantage, even at retailers.

Continue Reading Below

No 2: Increased productivity and boosted morale should show up instantly
Even if demand returns, Walmart will be unable to take full advantage unless it executes better. Walmart has been plagued with poor execution, most notably, the shocking admission in 2013 that it was losing out on $3 billion per year because of improperly stocked stores.

As an encore, last year, the New York Times released a leaked memo that outlined poor grocery conditions. The Times specifically mentioned dented and soiled milk cartons, poorly stocked produce, and a residue-streaked shelf.

The memo was leaked by an unhappy manager, and is reflective of both poor morale and understaffing. For workers who receive pay increases, this should directly increase their morale, and lead to increased productivity. Although this sounds unimportant to Wall Street traders, clean and well-stocked stores are important to shoppers.

Selling Walmart? Ask yourself why...
If you're someone who's hammering the stock down on the announcement that Walmart's increasing wages, ask yourself if you're overreacting. Using the least-favorable assumptions for Walmart results in an additional $1.82 billion in employee costs -- less than the amount it was reportedly losing in stockouts. Last fiscal year, the company reported selling, general, and administrative expenses of $91.3 billion, and total operating expenses of $449.4 billion leading to increases of 2% and .4%, respectively, while all other factors held constant.

While it's true that retail is a rather low-margin business, Walmart should be able to recoup these costs by cutting elsewhere, or growing sales by monetizing newly motivated employees. Wall Street and short-term traders should ask themselves if they are selling Walmart on its fundamentals, or out of a sadistic belief that an employer should not take care of its employees.

The article 2 Reasons Why Walmarts Massive Wage Increase Is Smart originally appeared on Fool.com.

Jamal Carnette has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. 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.