Will Pay Hikes at Costco and Shake Shack Needlessly Hurt Their Stocks?

By Markets Fool.com

Costco remains determined to keep its competitive advantages over rival Wal-Mart even as it faces the prospect of slowing growth. Image source: Mike Mozart.

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With the latest leg in Wal-Mart's minimum wage pay raise taking effect last month, rival Costco has said it too will raise the pay of employees on the lowest rung of its economic ladder. It will increase their starting pay from a range of $11.50 to $12 per hour up to $13 to $13.50 per hour.

Already well compensated when they reach the top rungs -- about $22.50 per hour, which can be attained after around four years with the company -- the pay hike keeps Costco competitively ahead of Wal-Mart and its warehouse store Sam's Club, whose employees just saw their minimum rate rise to at least $10 per hour.

It's not just Costco and Wal-Mart battling it out for entry level workers; the restaurant industry is seeing the same game play out. McDonald's raised the pay of its new hires from $9 to $10 an hour last year and says it's leading to a better customer experience, which is translating into higher sales. While that's a dubious claim since there were many factors involved in the burger joint posting back-to-back quarters of higher comparable sales -- the first time in three years they were up, in fact -- it is causing competitors to raise their employees' pay, too.

Better burger shop Shake Shack also sees the need to offer a premium to the competition, whether it's on its burgers, its pricing, or the wages it pays its employees. Image source: m01229.

Shake Shack , for example, raised its workers' pay at the start of 2016 from $10.50 to $12 per hour as it, like Costco in its own particular industry, felt it important to keep its wages at a premium relative to the competition. It raised its prices, too, as a result -- the third time in a year and a half it had done so.

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Because Costco and Shake Shack are seen as higher-end outlets compared to their more pedestrian rivals, it would seem to make sense that working there should also result in a better pay rate. But do they really need to always stay at the forefront, or are they unnecessarily hurting their bottom lines?

Although the unemployment rate has fallen to about 5% nationally, suggesting the labor market is tightening and higher wages to continue attracting better employees may be required, the non-participation rate -- or the number of people who have dropped out of the labor force and aren't even counted in employment statistics anymore -- remains at a historically high level. The Bureau of Labor Statistics says around 93 million Americans, or more than 37% of the civilian labor force, are now out of the picture.

That means there are likely qualified workers ready and willing to fill positions without businesses unnecessarily incurring higher expenses. Yet if a company can increase sales fast enough, wages, even higher ones, represent a smaller percentage of those sales.

Shake Shack, for instance, grew revenues 63% in 2015 so that labor costs, even though greater on an absolute basis, represented 25% of its sales, down from 26.3% in 2014.But last year was a special year for the better burger shop: It had an IPO, which attracted a lot of media attention, and management admits the surge it saw in 2015 can't be maintained. Same-Shack sales were at a high of around 7% or so a few years ago, and they have been falling steadily ever since. Management expects them to, at best, grow 3% this year.

Costco is also experiencing slowing sales growth. Revenues for the six-month period ending in mid-February were up less than 2% compared to near-6% growth a year ago. Similarly, comps absent fuel were up 5% compared to 7% last year.

Both Costco and Shake Shack may be proud they can pay their workers more than Wal-Mart or McDonald's can, but investors may start questioning the need if labor costs start eating up a larger percentage of sales -- and profits.

The article Will Pay Hikes at Costco and Shake Shack Needlessly Hurt Their Stocks? originally appeared on Fool.com.

Rich Duprey has no position in any stocks mentioned. The Motley Fool owns shares of and recommends Costco Wholesale. 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.