Before You Write Wal-Mart Stock’s Obituary

In the 1990s, no stock contributed more to the earnings per share growth rate of the S&P 500 than Wal-Mart stock. It had been an elevator upward delivering 16% annual earnings per share growth throughout the decade, fresh on the heels of delivering 31.5% annual growth between 1972 and 1990. From 2000 through 2012, the party continued, as Wal-Mart grew earnings per share from $1.40 per share in 2000 to $5.02 in 2012. Although the best gains came to Wal-Mart’s early investors, participating in the growth of the business between 1972 and 2012 had been a blessing for any investor that chose to buy Wal-Mart outright instead of investing in something like an index fund.

The past three years have not been as kind to Wal-Mart shareholders. Between 2012 and 2015, earnings per share have exactly come down a bit. Wal-Mart made $5.02 in 2012, and is only expected to make $4.85 in 2015. If correct, this will mark the first three-year period in the company’s publicly traded history in which earnings per share declined. After a big hike from $0.365 in 2012 to $0.47 in 2013, the quarterly dividend growth at Wal-Mart has come down as well. The quarterly dividend went up a penny in 2014, and then went up another penny in 2015. After getting used to 15% raises in the company’s dividend, the short-term trend towards 2% dividend hikes has been an abrupt shift of pace that has disappointed some of the company’s investors.

Some of the worries about Wal-Mart’s stock are related to one-time events. The company recently pledged to raise the compensation for its employees to $1.75 above the minimum wage, and this will affect over 500,000 employees. Many managers will see their pay increase from $13 an hour to $15 an hour. This announcement will lower the company’s overall profit from $16.8 billion to $15.7 billion. This is why companies like Wal-Mart holler any time critics suggest raising the minimum wage. Each $1.75-$2.00 in wage increases cost the company over $1 billion in net profit.

As for the slow dividend increases, I find the move prudent for long-term management even though it is not popular with shareholders right now. For the past fifteen years, Wal-Mart has clearly established itself as a company that needs to buy back large amounts of stock. It is a necessity that faces certain companies like Exxon and IBM because the reinvestment opportunities are not vast enough to grow earnings per share naturally. Wal-Mart moves $497 billion in merchandise per year. If it wanted to grow sales by even 5%, it would have to sell $24 billion more goods.

That is not realistic, so Wal-Mart tends to keep the payout ratio in the 30% range so that it can buy back 100+ million shares of stock per year. The dividend has crept up to 40% of earnings, and it can’t really give shareholders dividend growth in excess of earnings per share growth because it would compromise the company’s ability to manufacture earnings per share growth over the long run.

Wal-Mart has reduced its share count from 4.4 billion in 1999 to 3.2 billion today. It made $5.6 billion in 1999, and makes $15.7 billion now. Even though profits have increased by 280%, owners have actually experienced 391% overall growth (without counting dividends) because Wal-Mart has been so good at repurchasing its own stock.

I think people forget how much power Wal-Mart has over the rest of the businesses in corporate America. Other companies have significant reliance on Wal-Mart to grow their own businesses. Take a blue-chip like J.M. Smucker. It is one of my favorite businesses in the whole world, but it also relies on Wal-Mart stock more than any other blue-chip to spur on its growth. Smucker does $7.6 billion in business per year, and over 30% of sales ($2.35 billion) come from Wal-Mart alone. A third of your jelly and jam dividends come from the fact that J.M. Smucker sells its goods at Wal-Mart.

There are five other blue-chip stocks that derive significant chunks of their business from Wal-Mart: 26% of Kraft sales occur at Wal-Mart, 21% of Kellogg sales occur at Wal-Mart, 26% of Clorox sales occur at Wal-Mart, 27% of Hillshire Brands sales occur at Wal-Mart, and 24% of Tootsie Roll sales occur at Wal-Mart. Pepsi, meanwhile, only relies on Wal-Mart for 12% of its sales.

The strength of the U.S. dollar has lowered Wal-Mart’s reported profits by $0.15 per share. The decision to give employees a pay hike has lowered profits per share by $0.29. In the short term, this has exaggerated effects for Wal-Mart shareholders. You will see earnings per share of $4.85 this year rather than $5.29 per share as you might otherwise expect. This strikes me as inherently part of the business flow of a large enterprise. When companies are mid-sized, same-store sales tend to suffer but it gets ignored because fresh openings drive earnings per share growth rates up so that the temporary business struggles get papered over.

That is why I wrote an article about Starbucks recently. At Starbucks, same-store sales grow at 7%, and that is unusually high. So I gave it credit for being a great business. At Wal-Mart, the company is rolling out 500 new locations per year. That will augment returns, but isn’t enough to conquer currency headwinds and sluggish same-store sales simultaneously.

I remember Peter Lynch writing in One Up On Wall Street that the funny thing about investing is that people give up on some of the largest, most profitable companies in the world as soon as they deal with short-term hiccups. He called the expected 20% to 40% short-term gain that instantly follows a series of good news for a struggling company one of the most underrated ways to make money in the stock market. If the growth rate goes up from 3% to 8%, you not only capture that beneficial transition over the long run, but you also get to capture the instant switch from 14x earnings to 19x earnings in the short run.

People tend to discard the Wal-Marts, Shells, McDonalds, and IBMs of the world anytime they have difficulties growing revenues. It seems to me that people are quick to forget that these companies go through business cycles, and even at the bottom, still make billions of dollars in annual profits. It’s hard to mess up going through life collecting companies like Wal-Mart at 15x earnings or Shell with a 6% dividend yield. Warren Buffett was probably right when he said that value investing would never become truly popular, as it requires a certain temperament that looks past recent news and develops special appreciation for companies temporarily cloaked in low expectations.