Rose Blumkin, the founder of the Nebraska Furniture Mart, once said: “If you have the lowest price, they will find you at the bottom of a river.” For operators that seek to compete on price, that insight is both a blessing and a curse. The low-cost operator can quickly accumulate customers when it is the cheapest guy in the neighborhood, but because there is no inherent loyalty, can also quickly lose customers when a lower-cost operator enters the scene.
Wal-Mart stock (WMT), which had traded at $63 before the 2008-2009 financial crisis, was still trading in that range five years thereafter when the stock was at $67 in 2013, before investors pushed it towards $110 (a valuation of 24x trailing earnings!) in January 2018.
For long-term Wal-Mart shareholders and those with an interest in the stock, it is worth pondering: What caused the fall and rise and partial fall again?
Throughout the past decade, Wal-Mart was confronting the limits of its size. It sells half a trillion dollars worth of goods per year. As the adage goes, the investors of today receive no return for yesterday’s growth. Long-term shareholders of Wal-Mart only receive returns for what Wal-Mart is about to do with its base of $450-$500 trillion in sales onward.
Five years ago, Wal-Mart began experimenting with moving the profit needle upward. Even a 0.1% of an uptick in profits has enormous consequences for shareholders when the revenue base is that high.
So Wal-Mart started playing around to get that extra 0.1%, as Wal-Mart’s long-term 3.5% profit margin ticked up to 3.6%. It started raising prices here and there, and even worse, playing inventory by understocking some items (thus forfeiting the one advantage brick-and-mortar retailing maintains over online purchases, immediate availability).
Over the past year, the zoom in Wal-Mart’s stock has been the result of (1) Wal-Mart refocusing its efforts on being the low-cost provider and not trying to grab that extra bit of profit for competitors to potentially undercut; (2) Wal-Mart figuring out how to leverage its store presence by rolling out an online order and pick-up system that is actually working and leading to surprisingly high-ticket pick-up orders; and (3) investments in jet.com and India’s Flipkart have shown promise that Wal-Mart can position for the future, with jet.com growing online sales by 40% in the past year alone and showing the benefit of Wal-Mart’s distribution and financial heft.
With Wal-Mart trading at $83 per share, at a valuation of 16x this year’s expected earnings of $5 per share, and a dividend yield of 2.5%, I would expect shareholders to achieve returns of 8.5% for the long haul (that is, 2.5% dividends, 2% share repurchases, and 4% organic earnings per share growth).
If someone owned a portfolio of 50 various holdings, I would expect Wal-Mart’s performance to be somewhere between the 20th and 25th spot–right in that “moderately above average” category. If I had to choose between Wal-Mart and the S&P 500 for the next decade, I’d take Wal-Mart due to the quite substantial starting valuation difference. If I had to choose between Wal-Mart and the S&P 500 for the next thirty years, I’d take the S&P 500 because of the inherent uncertainty in retail.
If I were put in charge of a corner grocery store, I would not try to compete on price. I’d roll out high-quality meat and dairy departments, sell exotic beverages, and try to build a higher-end shopping clientele that have a strong experience shopping at the store–cool air conditioning in summer, warmth in winter, nice lightning and cleanliness. Three entities–Wal-Mart, Amazon, and Aldi–would wipe me out in short order if I tried to compete with them on price, and I suppose that is an endorsement of the returns that will accrue to all three for being the low-cost industry operators.