The Most Pressing Reason Yet You Want to Avoid Investing in Retail Stocks

Keith Fitz-Gerald Jul 03, 2015
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President Obama announced last week that he’s directing the Department of Labor to mandate higher overtime pay for anybody making $50,400 or less per year. Coupled with rising minimum wage standards, that’s given many people reason to cheer.

Yet, this is absolutely the last thing you want to see as an investor.

To be clear, I think anybody who wants a job should have one and that it should pay well. So let’s get that off the table right away.

What matters here is that the President’s actions just doomed millions of hardworking Americans to the unemployment line and, at the same time, just made it harder for every retailer – large and small – to turn a profit.

It’s the latest in a long line of reasons why every investor should think twice about holding retail stocks.

The Government’s Latest Rule by Fiat Targets Five Million Workers

Last Monday President Obama announced via the Huffington Post that he’s directing the Department of Labor to raise the standard for overtime pay to anyone making $50,400 or less per year.

What that means is that every salaried individual in that wage range will now receive 50% more pay each hour for every hour beyond 40 they work each week.

Currently, the bar for overtime pay for salaried workers is set at $23,600, targeting mainly workers who are receiving minimum wage or close to it.

Under the old rules, for example, someone making $15/hour on a 40-hour week would earn $30,000 a year, making them exempt from overtime pay. But if they work 55 hours a week like many store and restaurant managers, they’ll now be entitled to an additional $337.5/week, or a 56% pay raise.

It’s been estimated that five million workers will receive a bigger paycheck as a result.

As always, though, there’s a fly in the ointment.

When You Tax Employment, You Get Less of It

President Obama believes that a nation-wide minimum wage hike in this country is long overdue. Unable to get Congress to take legislative action on his call to raise the minimum wage from $7.25/hr to $10.10/hr, he’s turned to executive action. That’s because massively expanding overtime pay is the closest President Obama can come to making his minimum wage hike happen without Congress.

But, he might want to listen to what Congress has to say on this matter.

The Congressional Budget Office analyzed the effects of the minimum wage hike the President proposed, and found that 24.5 million workers would get a wage increase. At the same time, 500,000 workers would see their jobs vaporize once their labor became too expensive for their employers to afford.

Put bluntly, this means that for every 49 workers who see their pay go up, one American worker will see his or her paycheck go to zero.

You could argue like many proponents do that this is an acceptable situation, but it’s actually only the tip of the proverbial iceberg.

No Government Mandate Can Keep Down the Overtime Regulation’s Inflationary Impact

In 2013, economist Arindrajat Dube, Assistant Professor of Economics at the University of Massachusetts, testified before Congress in favor of a minimum wage hike. He argued it was overdue thanks to increases in worker productivity.

He also acknowledged that a 10% increase in minimum wage could be linked to a 0.7% increase in prices. On the surface, that sounds great. Who wouldn’t like wages to grow 10x faster than prices?

Unfortunately, you cannot outrun the math.

What the President and proponents of the hike are missing is that companies will only stand for a 50% increase in labor costs only so long. They’ll shift the burden to consumers – including the very workers that these wage hikes are supposed to benefit.

Here’s an example that may help put this in perspective, albeit a very simple one.

Let’s say ABC makes a widget they sell for $15. Approximately $5 is labor and $5 is materials. That means they’re bringing $5 to the bottom line.

If you bump wages up to $8 an hour and keep materials the same that means the company’s profit just dropped to $2.

Many people don’t believe there’s anything wrong with this. Those corporations already make too much money, goes the reasoning.

In reality, they don’t make that much money.

Most Americans believe that corporate profit margins are around 36%, when in reality the real numbers are between 6.5% and 7.5%, according to YahooFinance.com and Professor Mark J. Perry, Professor of Economics at University of Michigan.

That means thousands of companies employing millions of Americans are at risk with restaurants and retailers at the top of the list because labor in those businesses can account for nearly 50% of operating costs.

Here’s what you need to know:

  1. Companies will only absorb higher costs for so long. They are in business to profit and will raise prices to compensate, which means that the cost of anything requiring minimum wage production and/or overtime goes up.
  2. Growing revenues drive earnings which, in turn, ultimately translate into higher stock prices. Anything that interferes with that equation (like mandated higher wages) puts your retirement at risk.
  3. Periods of falling margins coincide with falling markets. For example, profit margins fell from an average of 7.1% to 4.6% from 1965 to 1970 and the S&P 500 went nowhere during that time frame according to Barrons. Margins crested at 10.1% in 2006 only to fall by half in 2008 even as the stock markets lost nearly 50% of their value and trillions of dollars in hard earned savings vanished.

Put simply, higher wages are not the “wash” that many people think.

Instead, they’re an unmitigated loss because the higher wages everybody thinks are so great are really an instant and hard-hitting tax workers and consumers alike will feel every day. Instead of helping, it will in fact rob them of purchasing power and diminish their savings by making everything more expensive over time.

Retail is Especially Vulnerable to Unforeseen Consequences

That’s why the National Restaurant Association came out strongly against the proposed overtime rules last fall.

This makes sense if you think about it. Wendy’s, for example, has a profit margin of just 5.12% and any hike in wages will result in a corresponding offset to consumers and a bottom line hit to earnings.

Restaurant chains that already have low profit margins like Wendy’s could be especially hard hit.

McDonald’s won’t fare much better. Bloomberg Business suggests that the price of a Big Mac will rise by $1 or about 25% to compensate. That’s going to send price-conscious consumers somewhere else at a time when the chain is desperately trying to reclaim its place in the fast-food arena. Anybody who owns Mickey D’s stock is at risk of losing big time.

Wal-Mart is in much the same boat.

The company proactively raised its minimum wage to $9 in an attempt to get ahead of the legislative 8-ball and curry goodwill. Now, they’re going to be stuck paying time and a half on wages they’ve already increased 19%!

Literally thousands of companies are going to suffer and if you’re investing in them, you’re going to get caught, too.

Fortunately, there is a way around all this.

By investing in high margin companies like Apple Inc. (NasdaqGS:AAPL) and Google Inc. (NasdaqGS:GOOG) or any of the other companies we talk about frequently, you are immediately gaining the protection that comes with higher margins that are less susceptible to this kind of government mandate. Further, and perhaps most importantly, you are pursuing the growth that comes with each of our Unstoppable Trends, every one of which is backed by trillions of dollars in spending the world can’t live without.

In closing, let me re-emphasize that I’m not against higher wages when they happen for the right reasons.

I say that because higher wages are the inevitable outcome of a brightening economy, companies that compete for talent, and a vibrant consumer motivated to spend money because his or her quality of life is getting better.

Not government policy.

Until next time,

Keith

20 Responses to The Most Pressing Reason Yet You Want to Avoid Investing in Retail Stocks

  1. Joe Blow says:

    Tough Beans! America elected this president not once but.twice! The american people want it all! The wealthy corporation’s and large retail, banks etc will not be happy and neither will the people, but tough beans!! The is a system that’s corrupted by greed and in the short term future this country is going to wake up one day to discover we are just like other third world countries suffering daily. Just the way the Liberals wanted it all to be.. Enjoying Paradise in Mexico Lindo..

  2. Ian Melville says:

    Hi Keith,
    Do you think this is also a move to potentially to prod inflation by causing the retailers to pass on the cost? Would’nt this then spur the Fed to raise rates?

  3. Mike Cooper says:

    Having worked in retail management for a number of years, I am always amazed at why “economists” are called to give “expert” testimony on minimum wage cases. The reality is salary has to be controlled as a % of sales – when sales increase, so can salaries. When sales drop, or hourly wages are forced to rise, the salary dollars % MUST drop, either through cuts in hours or layoffs.
    The other factor many experts ignore is the “wage compression” which occurs. Look at your chart above, and you see the average for many of these workers is already over the minimum $7.25. Some workers may have 2-3 years experience to justify their higher salary. When the minimum is raised to say $9, that experienced worker who before was earning 50-75 cents over minimum, now finds their increase just goes to $9.10, and their hours are cut. So, at $7.75×35 hrs, the worker earned $271/wk. Now, at $9.10×30 hrs, they get $273!

    Productivity increases might work in industry, where actual products are being made and automation can be used to help employees work more efficiently – meaning more production from fewer man hours. Smaller retailers face minimum staffing requirements, so their only way to combat higher(forced) salaries and maintain the salary cost % is to increase prices or reduce opening hours, both of which often lead to less sales, not more productivity. Neither helps the worker either, because they earn the same or less, and now must pay more for what they have to buy.

    I have read that studies show increasing minimum wages has no negative effect on the economy, but in my experience I have seen the effect it has on individual workers – the inexperienced youth who can’t get a job, the 15 yr veteran shoe salesman who is back to making just 10 cents more than minimum – again; and the single mother who was expecting a nice boost to her weekly pay and has her hours cut at the same time she is marking up the price of the jeans she sells and also buys for her kids. This is just another way for politicians and the NGO’s to pretend they are “doing good”, just to help them raise money for their next campaign.

    • yngso says:

      So what’s the excuse for not raising all wages gradually all the time, enough to beat inflation, and then some if profits are good? Instead we have this constant war about inreases, downsizing etc. Any company that can’t pay decent wages should automate, downsize or go out of business. That’s why we have govts, because individuals and businesses can’t take care of all the institutions and infrastructure that’s needed. Lawmakers need to make general rules that level the playing field, also about wages…

      • Kevin O says:

        Look closely, the Government does not “level the playing field” They play favorites, and buy votes. Without a low starting wage, there is no incentive to learn, experience and grow as we move forward through our lives.

  4. WAYNE says:

    I can’t wait for 2017

  5. Earl says:

    Unfortunately those who have never held a real job, ie President Obama, don’t have a clue how the economy really works. I think he might best study Greece to learn the dreadful consequences. What continues to amaze me is why we as a country don’t put a stop to his running around congress and doing by presidential decree what the people will not do through their representatives.

  6. John R Stockhausen says:

    RE: Keith Fitz-Gerald,
    Again, as always, all of your Emails are really appreciated more than you know to me. “I really hope you keep up this This Total Wealth Emails”.
    This is what I wanted to ask you; Is it still “Safe” to hold (EKSO & Consolidated Water) in our Portfolio when the “Bond Crash ” comes to the U.S.???
    Thanks so much ahead of time.
    Sincerely Yours, John R Stockhausen

  7. David Waldman says:

    I don’t agree either with you or the Congressional Budget Office.

    Retailers, restauranteurs, and others are already operating with minimum staffs, so they (Walmart, Burger King, McDonalds, etc.) will have no choice but to pay, just as they presently pay over $10/hour in Canada, and will shortly pay $15 in Alberta. In fact, Walmart just announced they are opening many more stores in Canada.

    What I think will happen is that they will adjust their prices to maintain their margins, and I understand that Walmart will have to increase their Mac & Cheese by 2 cents a package. Outside of stockers and cashiers, they have very few employees, who work very hard.

    But their employees won’t be working for starvation wages, and they have a huge pent-up demand, which will stimulate the U.S. economy.

    • yngso says:

      It’s unacceptable that Walmart and others can make the taxpayers compensate for them not being willing to pay decent wages.
      This is a political problem more than a business one. If politicians aren’t doing their job we need to elect better ones.
      If that means that some – or even many – products and services become little bit more expensive, who cares? Then we just have to learn to prioritize better when we’re short of cash. When many people have more cash to spend because of a better salary, that’s good for the real economy…

      • Susan says:

        yngso, you are thinking there is a lot of room for Walmart to absorb the extra pay for employees because they make such a big profit. They don’t. Their prices are very low, and even with their big buyer discount, they won’t be able to simply take less profit and still pay all their bills and pay their investors. In the article you must have missed how Wendy’s makes a 5.12% profit. Walmart is probably similar. The Walmart prices will go up very much more than you think. It will pay for your paycheck and Pouf!!!~ goes your raise. All the companies will be charging much more for everything. You won’t be better off. Businesses must make a good return to their investors. That’s how YOU get ahead. You must buy stock in good companies. A little at a time, Whatever you can afford because that’s the end where you make money. Not getting paid by the hour.

  8. Tom Stanley says:

    Let’s raise the minimum wage to $50.00 an hour or even $100.00. All the burger flippers can be fired and replaced by machines. Momentum Machines in SF produces a battery of specialized machines, four of which are designed to replace the burger flippers. Haven’t seen the machines in action , except in a video. But the machines can do the job better and without mistakes, arguments and sick days. The just need one person there to fill the hoppers. They do everything, one machine will even mix different types of meat for the burger. You select how you want it, it is prepared, wrapped, bagged and the receipt is stapled to the bag. Someone must have another machine to mix shakes!

  9. Tom Stanley says:

    Personally I have my portfolio spread out over 77 different stocks, each with it’s own degree of success, some future success hopefully

    • yngso says:

      I do something similar: I have small amounts in stocks and ETFs in markets and sectors that aren’t great now, but with a lot of potential. Then I try to keep some cash ready to pounce on whatever starts to move…

      • yngso says:

        Please let me explain a bit more: Remember our discussion about Samsung, customer service in general and getting repairs done? The only broker I can use right now won’t explain me how to use their watch list, so I use this somewhat primitive method. Maybe the good thing about doing it this way is that I start buying the assett while it’s still cheap…

  10. yngso says:

    Sorry, I have to be the contrarian again, I’ll try to be brief:
    That was an interesting title, too bad the article wasn’t about that. Apple is a tech AND consumer company. I stay as far away friom the consumer that I can, because moods and fashions change too quickly.
    Overtime is a marginal expense, mainly incurred when companies rush to fill an order or meet a deadline, incidentally often right before a major payday. Companies that pay too much for overtime need to take a hard look at their hiring practices.
    Minimum wage is another discussion.

  11. joanne says:

    Yngso did you read the article? Managers in retail and restaurants often work more than 40 hours/week. equals overtime for many employees expensive for retail sector.

  12. J R. says:

    Mr. Keith this is Juan. I hear you will traveling zoom! ??
    When you got time sent to me the days you will travelin to NYC and King County this year. My 15678398
    Then I will buy Startbucks caffe.
    Got Bless you and yours
    Thanks
    Juan

  13. James Timmons says:

    In the hypothetical where all fast food retailers are forced to pay higher wages, there will be no customer shift because every retailer has to increase prices. Unless the workers are spending all their money on fast food, they will be better off. Wall Street bankers will not stop eating at high end restaurants, so there will be some effective redistribution of wealth to lower paid workers in that market. In considering these issues, it is important to recognize that people who have no effective stake in an economy or a society have no reason not to destroy it. I, for one, am willing to be less rich to be able to live in a safe and cohesive society. Guns and gated communities will not adequately protect the rich when there is civil war because people cannot afford food and clothing. If business does not want goverent attempting the wealth redistribution, they need incorporation bylaws that consider employee and societal good on a par with profits. Regulate yourself or be regulated.

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