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My 'Barely Related to Investing' Rant for the Month/Year

February 13, 2014 | About:
The Science of Hitting

The Science of Hitting

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Note - as the article suggests, this is loosely (if at all) tied into investing; I promise to keep such rants to a minimum, though I do believe the overarching point is relevant to investors.

According to Wikipedia, The Wall Street Journal is an international daily newspaper with a special emphasis on business and economic news. Most would agree that’s a fair description.

As such, I’d assume the WSJ has a team full of individuals with a deep understanding of business and economics. The paper’s quality is a testament to that expertise. I would assume that when articles come across the editor’s desk with questionable facts or figures, they are checked for accuracy. Anything that fails to pass the smell test is likely rejected until proven otherwise.

This may be a bit of stretch, but I would also suggest that should extend to the editorial page. One’s opinion should not take priority over financially accurate information. Any questionable data should be rejected, or require citation and explanation by the author; if one places an emphasis on integrity and impartiality, this is a must (of course it’s questionable whether this is a top priority at most “news” organizations these days).

That brings me to the point of this article. In Monday’s edition of the paper, The Wall Street Journal featured an editorial by Robert Strayton, the former chief strategy officer of Hill & Knowlton, entitled “A Minimum Wage That Will Work” (here). Here’s the first paragraph, in full:

“The president's call for a $10.10 minimum wage applies the worn-out notion that higher wages create more jobs. Despite repeated minimum-wage increases over the years, we have seen a continued flight to the sidelines by people who are unable to find jobs because they don't exist. Many jobs don't exist because employers refuse to hire people at such wages. Isn't it obvious that, with a higher wage, McDonald's $1 menu, for example, would cost $3, few would buy it, and Mickey D would have less revenue and far fewer jobs?”

That’s a pretty astounding change: With an increase in the minimum wage to $10.10 an hour, Mr. Strayton believes actually, states as fact (“McDonald’s $1 menu… would cost $3”) that MCD would be forced to charge $3 per McChicken. Unfortunately for the reader, he does not make any reference to where this number came from. Let’s look at the numbers on our own to see if that meshes with reality.

In the year ended Dec. 31, 2012, McDonald’s reported $18.6 billion in sales from company-owned restaurants (we’ll use data from company-owned restaurants because we do not have franchised restaurants operating expenses); of that $18.6 billion in sales, McDonald’s spent $4.7 billion or 25.3% of revenues on Payroll & Employee Benefits.

With the federal minimum wage currently at $7.25, a move to the $10.10 called out in Mr. Strayton’s article would result in a nearly 40% increase in this line item; increasing a quarter of the company’s expenses by 40%, assuming all others remain constant, would result in an overall increase in company owned operating expenses of about 10%. The price increase to the consumer, in order to cover the additional expenses for MCD, would actually be less than 10% of what Mr. Strayton has estimated (this is before adjusting for the fact that nearly half of all states currently have a minimum wage rate in excess of the federal minimum, employees that get paid the least tend to work the fewest owners, many employees make somewhere between $7.25 and $10.10 and might not receive a proportionate raise to the lowest paid employees, etc.).

(I want to be clear about something this is not a political statement on my part; if someone wrote an article saying a hike in the minimum wage would have no impact on the cost of fast food, I would be writing the same thing from the other perspective. I have not looked at the issue of minimum wage increases closely enough to have a firm opinion one way or the other.)

That’s math that requires no interpretation besides a few readily available facts. The numbers put forth by Mr. Strayton appear to have no basis in reality. Either Mr. Strayton or (in my opinion) somebody at the WSJ should have run these numbers; if they don’t own a calculator or know how to read a 10-K, they could’ve searched online to find supporting evidence for Mr. Strayton’s figures. If they’re like me, they will end up searching for a long time, with nothing to show for it.

But all is not lost – looking for minimum wage and fast food studies yields some results. One of the first links that popped up in my search was a study from the University of Massachusetts, Amherst, completed less than six months ago (here). For our purposes, here’s the result of the study:

“We presented these findings in a petition supporting H.R. 1346 signed by over 100 professional economists. In particular, we described how raising the minimum to $10.50 would impose a cost increase to the average fast-food restaurant equal to 2.7 percent of their sales revenue. In other words, assuming all else equal, the average fast-food restaurant could fully cover the costs of the $10.50 minimum wage by raising their prices 2.7 percent. This is equivalent to increasing the price of a $4.50 Big Mac to $4.60… We extrapolated our 2.7% figure from the findings of five empirical studies firmly grounded in industry-specific data. Each of these studies measures how the business costs of fast-food establishments increased in response to minimum wage hikes in the range of 10% to 65%.”

This study from David Card and Alan Krueger looks at a minimum wage hike in New Jersey in the early 1990s with a conclusion that’s comparable to the study presented above (here). Finally, a 2006 paper from the Employment Policies Institute (which according to Wikipedia is a fiscally conservative non-profit think tank) also suggests the figure from Mr. Strayton is wildly inflated (link in article here).

As I noted, I’ve looked through plenty of articles on the topic, trying to find any that would support Mr. Strayton’s claims but I can’t (though I found some claims that were even more outlandish, with a notable one from Congressman Mullin of Oklahoma: when asked about the minimum wage, he responded “you guys want to pay $20 for a hamburger at McDonald’s?”)

Even industry trade groups only offer vague claims; for example, here’s a statement I found in an article from the Wisconsin Restaurant Association: “If you double the minimum wage and that takes everybody's wages up, that's going to be a cost increase that a restaurant owner can't just absorb.” That’s a fair point, and well worth consideration; unfortunately, we don’t know if that means a cost increase of 2%, 200%, or somewhere in between. An article from The Heritage Foundation (here) takes a similar approach it discusses the risk to manual labor at higher costs of being replaced by previously uneconomic automated systems (again, worth consideration).

But none of those items suggest prices will triple not even close; how can numbers that have no apparent basis in reality be published in one of the leading financial newspapers in the world?

I’ll end with a quick quote from Charlie Munger (Trades, Portfolio) that I think is applicable to this article:

“Recognize reality even when you don't like it especially when you don't like it.”

While this article may not relate to investing directly, I think it says a lot about human nature; just like in financial markets, people in the religious and political world are often “sure” of things that are simply unknowable, and seek out information that confirms what they already believe.

As an investor, reality must trump consistency of belief; push yourself to seek out evidence that contradicts what you currently believe to be true.

About the author:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

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Comments

batbeer2
Batbeer2 premium member - 8 months ago

Thanks for a well-written rant.

I think the Wall Street Journal made mistake.

But so did you.

You see, higher wages are reflected not only in the payroll but in most other items as well. A farmer gets about $300 for a ton of wheat. By my estimates, you can make 30k buns with that. So that's 1 cent per bun for the wheat that goes into your burger. The rest is either labor, energy or capital.

I could do the same exercise for the meat or the vegetables.

In short, the guy flipping the burger may be the only one who's paid directly by MCD but he is also the last in a long chain of workers who get paid one way or the other.

If you give everybody a 10% raise, all you've achieved is create inflation. Those that have lent others some money should be worried and those that are sitting on mortgages with 4% interest rates should be happy.

SeaBud
SeaBud premium member - 8 months ago

Batbeer,

You say "If you give everybody a 10% raise, all you've achieved is create inflation." That may be hypothetically true, but it is inaccurate and incomplete. First, nobody is saying give "everybody" a 10% raise, only raising the minimum wage. This is a much smaller pool of people. Second, raising wages does not give everybody a raise as some people (the 1%, for example) do not make their money in wages ( their income is primarily capital gains, dividends etc). Finally, all prices are not raised by raising the minimum wage as the monies earned are recycled in a subset of the economy (ie, not luxury goods but food, clothing). I do not think raising the minimum wage equates to inflation for the above reasons.

The Science of Hitting
The Science of Hitting premium member - 8 months ago

BatBeer - Fair point on the other increases throughout the supply chain - they certainly would add cost and boost the overall price increases by a few additional percentage points. I certainly don't want to suggest this is an estimate of any kind in case it reads that way (I don't know what the increase would be); I'm simply pointing out that calling for a 3X increase without any supporting material is questionable, to say the least. Thanks for the comment!

The Science of Hitting
The Science of Hitting premium member - 8 months ago

Seabud - Thanks for the comment as well; there are certainly a lot of details to be considered when making these estimates...

batbeer2
Batbeer2 premium member - 8 months ago

>> I do not think raising the minimum wage equates to inflation for the above reasons.

I agree.

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