The Investment Checklist

by Michael Shearn

  Great Employee Relations Can Translate into High Stock Returns

  Great managers know that if they treat their employees well, employees will, in turn, treat their customers well. Some of the highest-performing stocks within the S&P 500 have been run by CEOs who value their employees. One of the top performers is Expeditors International, whose stock price has increased 83-fold (up to July 2010) since CEO Pete Rose took over the freight forwarder in 1988. As Pete Rose once said, “You take care of employees. They take care of customers. And that takes care of Wall Street.”29

  HCL Technologies CEO Vineet Nayar instituted a new way of thinking about employees and customers at his company in 2005. In the book Employees First and Customers Second: Turning Conventional Management Upside Down, Nayar discusses his idea that employees create the most value at a company, because they end up knowing the most about the customer. His company, which provides global IT services, focuses its effort on making sure that employees are able to meet customer’s needs. Because employees understand the customer’s problems and how to fix them, Nayar makes sure that employees have what they need, and even makes managers accountable to employees. His results are impressive: From 2005 to 2009, revenues have increased by 3.6 times and operating profits by 3.4 times. HCL was one of the few companies that grew during the global recession beginning in 2008, and it also increased revenue by 23.5 percent in 2009.

  Read Articles Written about the Business

  As you read articles about the business, look for specific situations where the managers demonstrate they care about their employees. Here are a few examples:

  Howard Schultz, founder of Starbucks: Howard Schultz was asked in a 2010 interview about decisions that he had made that turned out to be unpopular with investors. He immediately brought up healthcare: Schultz estimated Starbucks had paid around $300 million in healthcare costs that year. Many investors wanted him to cut that cost, and one institutional investor even called him and suggested he had cover (meaning no one would criticize him) to cut healthcare costs because times were tough. Schultz decided not to cut the healthcare plan, saying he’d rather have the respect of his employees.30

  Richard Galanti, CFO of Costco: In an interview during the recession of 2007 to 2009, Galanti was asked whether he considered increasing the amount that employees pay for healthcare from 10 percent to a higher amount in order to save Costco $10 million to $20 million per year. Galanti and the other Costco managers declined to pass the cost along to employees, saying that in tough times they wanted to give their employees as much as they could.31

  Herb Kelleher, CEO of Southwest Airlines: When Southwest Airlines was founded, it struggled and was losing a lot of money because there was inconsistent ridership. Founder Herb Kelleher faced the dilemma of laying off employees or selling a plane. Kelleher said, “We’ve always taken the approach that employees come first. Happy and pleased employees take care of the customers. And happy customers take care of shareholders by coming back.” So Southwest Airlines sold a 737 plane and instituted a “no layoff” policy.32 This policy contributed to the success of Southwest Airlines: By 2010, Southwest Airlines was the biggest domestic airline in the country, with a market capitalization greater than the combined market capitalization of all its domestic competitors.

  In contrast, if you see management taking big bonuses at the same time they are cutting the benefits of the employees, this is an obvious warning signal. No matter how much managers say they value their employees, they will have no credibility.

  For example, when American Airlines was on the edge of bankruptcy, it successfully negotiated with unions for concessions in their contracts. Just days after those negotiations, former Chairman and CEO Don Carty made arrangements to protect the pension plans of senior executives. Carty later resigned because he had not disclosed these activities.33

  Does the Business Have Good or Bad Employee Relations?

  There are many questions you can ask to determine if a business has good or bad employee relations:

  Does management treat its employees as assets or liabilities?

  Does management talk about the contributions of their employees?

  Does management believe that retaining employees is critical?

  Does the business promote from within?

  Does management show employees how they can get promoted?

  Does the business invest significant resources in employee training?

  Does the business attract a great number of applicants?

  Are employees avidly recruited from the business?

  Are there large differences between the benefits that the top managers receive versus employees?

  Does management treat employees with respect when they lay them off?

  Does management listen to its employees?

  Does the business have a strong culture?

  Does the business have identifiable, shared values?

  What is the employee-retention rate?

  The following sections take a closer look at each of these questions.

  Does Management Treat Its Employees as Assets or Liabilities?

  To answer this, look for articles and note how the managers refer to their employees. For example, Michael Bloomberg says in his book Bloomberg by Bloomberg, “the main asset is not our technology, our databases, our proprietary communications network, or even our clients. It is our employees. Business must recognize employees as assets.”

  Does Management Talk about the Contributions of Their Employees?

  Nucor Corporation, a steel manufacturer, puts the names of all of its employees on the cover of its annual report. This gesture is a good indicator, and another is that Nucor always shows up on Fortune magazine’s list of “Best 100 Companies to Work For.” Good employee relations have likely helped Nucor become one of the best-performing stocks within the steel industry.

  Does Management Believe That Retaining Employees Is Critical?

  Shipping company UPS learned that it was critical for it to retain its drivers because experienced drivers learned the fastest routes and were more efficient in making deliveries. At one point, UPS management discovered that part of the reason for the high turnover rate for drivers was that loading the trucks was so physically demanding. When it discovered the problem, UPS promptly hired part-time workers to load packages: This way, the drivers could concentrate on their core competence, which was finding the best routes. As a result, the turnover rate of UPS declined. Anytime you see a management team focusing on the well-being of its employees so they can focus their time productively, this is a great sign.34

  Does the Business Promote from Within?

  A business that promotes from within has a better chance of retaining valuable employees because talented employees typically like to work in growing organizations with opportunities for advancement. A business that promotes from within will hire outsiders only when it needs to fill a specialized position. You can obtain this information by interviewing employees and asking them if most positions are filled with internal candidates or if the company actively recruits outsiders. You can also call the HR department and ask if the company has a policy of promoting from within. Most often, when a company promotes from within, it will highlight this in investor presentations found on the company website or on its employment websites.

  Does Management Show Employees How They Can Get Promoted?

  A manager’s job is to help his or her people grow. Great business leaders have sometimes measured their own success by the positive impact they’ve had on others, especially in helping employees reach their highest potential. In turn, this inspires employees to do great things for the manager and the company.

  In the book First, Break All the Rules: What the World’s Greatest Managers Do Differently, research firm Gallup sought ways to increase employee engagement. The study represents the largest worldwide effort to understand employee engagement, and was based on Gallup’s analysis of 10 million workplace interviews. Gallup found there a
re two employee sentiments that best predict engagement: “my opinion matters—I have a voice” and “somebody here cares about my advancement.”35

  If managers focus on themselves rather than developing their employees, this will cause employees to disengage from the business, and the managers will fail to develop a pipeline of future leadership at the business.

  Does the Business Invest Significant Resources in Employee Training?

  If managers are committed to employee training, this is a great sign that they have a long-term orientation. In contrast, a short-term oriented manager considers spending money on training employees a waste of money and a discretionary cost that can be eliminated. Look for examples where the business is investing in its employees through training by reading articles written in trade journals, such as Training Magazine.

  For example, Kip Tindell, Chairman and CEO of The Container Store, believes that putting employees first is a profitable strategy. He believes that one great employee has the same productivity as three good employees. Great people are hard to find and even harder to keep. So when The Container Store finds them, it pays them well and spends a lot of money training them. In fact, the average amount of time a first-year, full-time employee spends in training is 263 hours versus the retail industry average of 7 hours. This investment in employees contributes to low turnover. The average turnover in the retail industry is 110 percent, whereas at The Container Store it has historically been below 10 percent. This lower turnover decreases costs over time.36

  Does the Business Attract a Great Number of Applicants?

  Many people hear about good places to work and want to work there. Fortune magazine and regional magazines such as Texas Monthly publish lists of the best places to work. Whenever a business makes the list, it has more job applicants.

  Are Employees Avidly Recruited from the Business?

  During the 1980s, the most actively recruited managers in banking were at Wells Fargo.37 Finding a business with this characteristic is a positive sign because it means the business typically has a strong culture focused on execution. This does not mean employees would be successful at another business, but if they are avidly recruited, this is a sign that the business is well respected. Talk to headhunters who work in a particular industry and ask them what businesses they believe are the best places to recruit employees from and why.

  Are There Large Differences between the Benefits That the Top Managers Receive versus Employees?

  A successful CEO once told me, “If you are constantly reminding people at the bottom that they are not at the top, do you really expect them to be gung ho about the company?”

  Does Management Treat Employees with Respect When They Lay Them Off?

  One of the most revealing times to observe managers is during layoffs. You will gain a great deal of insight if you watch how they lay off employees. When a company fires employees, does it do so with respect, or do security guards escort employees out? If you learn that security guards escort employees out, this is a warning signal that management really does not care about its employees.

  The best-performing managers have always told me that when they have to lay off employees, they treat them with respect. One CEO told me that he would want the former employee to still feel close enough to the company to remain a company advocate and customer. These managers conduct layoffs or firings in an open manner and always disclose the reasons and rationale behind their decisions. They often give furloughed employees assistance in finding a new job. This way, the management team is able to instill a sense of security and confidence in those employees who are left behind, helping to keep more valuable employees from leaving.

  In contrast to this approach, you will often see a degree of insincerity by CEOs even as they announce layoffs. For example, one CEO stated, “Loyal and committed employees are critical,” yet at the same time, he was laying off thousands. Look for these negative signs when assessing whether a business has good employee relations.

  Watch out for those management teams that quickly announce layoffs the moment their business encounters a setback, such as a temporary drop in demand for its goods and services. There are many examples of businesses in the financial-services, retail, or real estate industries that quickly lay off employees when they encounter a downturn, but as soon as things start to pick up, they look to re-hire the same people—often at a higher pay rate. Instead, look for those management teams that attempt to hold on to their employees by taking the following actions:

  eliminating overtime;

  freezing hiring;

  offering voluntary retirement packages;

  reducing hours;

  reducing everyone’s salary;

  delaying raises;

  trimming spending on training, travel, or marketing;

  cutting temporary staff;

  delaying capital investments;

  and using less-busy employees to balance workloads elsewhere in the company.

  For example, in 2008 before Federal Express resorted to layoffs, it instituted pay cuts and temporarily halted retirement contributions.38 In 2000, under similarly slowing economic conditions, FedEx Freight also resisted layoffs on a large scale. In 2003, Pat Reed, CEO of FedEx Freight East, said they juggled hours and kept people working. He called the long-term payoff “indescribable,” saying it created loyalty and reduced turnover. Another benefit: “It gives you the ability to hire the best of the best.”39

  Does Management Listen to Its Employees?

  Managers can learn more by listening to the conversations of a few employees than by spending time setting down strategic visions. Many of the best ideas come from employees who are in the field, so it is critical for management to listen to them and have avenues for employees to channel information to headquarters. For example, the idea for the Post-it note® developed by the 3M Company came from an employee, and the Frappuccino® at Starbucks was invented by a store manager.

  Does the Business Have a Strong Culture?

  A culture is an organization’s shared values and beliefs, and it sets the tone for how employees treat customers. It is found in all businesses and varies from “this is just a job” mentality to “I love my employer.” For values and beliefs to be shared, they must be made clear and they must be modeled. A culture is typically built through the example of the top management of a business; employees will watch how top management acts as a cue for how they should act.

  An identifiable culture will attract employees most likely to agree with those values and beliefs. It also informs new employees about what is important at the company. For example, Whole Foods Market’s culture is so important to the success of the company that management sends existing Whole Foods Market employees to work at new store locations. They do this not just to help set up systems or train, but to help new employees understand which things are most important to Whole Foods Market. They call this transfer yogurt culture.

  One of the main advantages of a strong company culture is that a business is able to attract great employees and does not need to pay the highest salaries in order to recruit them. Most talented employees will gladly sacrifice pay for the right work environment. Furthermore, when employees feel like they are part of something important, they are more loyal to the business.

  In contrast, a business without a strong culture may be one where failures are not tolerated or where there is a lack of trust among management and employees. Businesses with weak or negative cultures may be inwardly focused and often do not possess good customer service. Employees are there to collect a paycheck, and most employees are not looking to develop their careers at the business.

  For example, HealthSouth (an owner of rehabilitation centers) had a hard-charging culture and was known for weak employee relations. When CEO Richard Scrushy performed audits of the rehab centers, he often performed a white glove test of the picture frames: After wiping his finger on a hanging picture, he would then wipe his finger on the clothing of the manager of the ce
nter. Any dust marks resulted in lower audit scores.40 Even though HealthSouth was quickly growing and its stock price was increasing, management-employee relations would be suspect based only on this or similar anecdotes. Regardless of short-term growth, a weak or demeaning culture is usually representative of a weak firm, and it should be a warning signal to investors.

  As you determine whether or not a business has a strong culture, look for engaged employees, because the happier employees are in their jobs, the more they will typically try to satisfy customers. The company grapevine is the swiftest means of communication, so tapping into it with a few employees can net you valuable information. The best way to determine if a business has a strong, healthy culture is to talk with mid-level and lower-level employees of a business. These are the people who interface with customers most often. It is one thing for management to say something is important, but if the rest of the company doesn’t buy it, it isn’t part of the culture.

  For example, if you could take the staff from, say, Dunkin Donuts, and plunk them down in a Starbucks, do you think you’d receive the same level of service? Not a chance. The Dunkin Donuts employees would not have been selected and trained to provide individualized attention and service: The entire atmosphere would be different. This difference shows up in your customer experience, and is one reason that Starbucks is able to charge a premium for its products.41

  To learn more about how a culture is built, I interviewed Bob Graham, co-founder of AIM Management Group, one of the nation’s largest mutual fund companies. AIM grew from a firm with five employees and no assets in 1976 to a firm with more than $57 billion in assets under management and a valuation of $1.6 billion in 1997 (when it merged with Invesco). One of AIM’s greatest strengths as it grew into a top asset manager was its extremely low employee turnover rate, which was (and still is) rare for a business in the investment management industry. The main reason for such low employee turnover was that AIM was well known for having a strong and energized culture. This allowed it to attract talented employees, and more important, to keep them. Graham recalls, “There was a sense of excitement working at AIM. It was known as a people-friendly company, and people wanted to come work there. It was fun and people didn’t leave because they had the excitement of building something everybody was proud of.”