I believe students of investing will be looking back in 2025 to think, “Wow, Wal-Mart was pretty cheap at $60 per share in 2015. It was a classic example of Peter Lynch’s ‘blue-chip with a solvable problem’ theory.” The earnings yield on the stock is 8%, and is almost 9% when you measure Wal-Mart using a constant currency metric. The dividend yield is 3.25%, and the dividend payment itself has increased every year for decades. Although this explains why it won’t take much for Wal-Mart to give shareholders satisfactory returns from this point forward, it is worth taking a moment to pause and examine how Wal-Mart got itself in this position in the first place.
Mistake #1: Wal-Mart sought to improve the velocity of its inventory by reducing the amount of products on hand by 37% compared to 2005 figures. This boosts short-term profits–a corporation makes more money when it has 2,000 chocolate bars on hand and sells 1,900 per month than when it has 3,000 on hand and sells 1,900. The problem is that, as perpetual efforts to boost profitability continue, Wal-Mart has inched past the point of perfect efficiency. Instead, it has reached the point with many items where it carries 1,800 chocolate bars on hand and has a market demand for 1,900 in a month.
Unusually high volume sales, or any volume sales that exceed product expectations for a given month, lead Wal-Mart to develop a shortage and rely on the substitute goods model. The substitute goods theory argues that people may have particular brand preferences, but it’s not a dealbreaker–if they don’t see their favorite Lindt chocolate bar in the aisle, they will just buy a Hershey bar instead.
It is my contention that Wal-Mart has underestimated the brand dedication of its customers. Forums are filled with people complaining that Wal-Mart perpetually has that Grand Opening look to it, in which aisles are filled with empty slots of products that people want to buy. As a result, the customers miss out on the product they intend. It is difficult to quantify–it’s hard to empirically measure opportunities foregone!–but I would wager that Wal-Mart’s earnings per share are materially affected by a combination of (1) people not buying the desired item at all rather than switching to a substitute good, and (2) people gradually shopping at Wal-Mart less after a recurrence of not seeing desired items in stock.
Mistake #2: Wal-Mart has reduced the number of employees by 42% per square foot since 2005. Even during the Christmas season, you will have a situation where only four or five checkout lines are open at a time. This has been mitigated somewhat by the rise of self checkout lines, but the average wait time at Wal-Mart is 8.52 minutes. It was 5.23 minutes back in 2005. The lower staffings detract from the experience, and I would also argue there is a constant cultural shift that militates against patience. If people can find alternatives to get in and out quicker, they might visit the competition even if it costs a bit extra.
Mistake #3: About those profit margins…In the past ten years, Wal-Mart has increased its profit margin from 3.2% to 3.8%. That may not seem like much, but it has provided an opening for competitors like Aldi, Kroger, and even Target to compete with Wal-Mart on price. In fact, many people have found that select items (plus maybe a coupon or two) provide better savings than what is available at Wal-Mart.
In the 1980s and 1990s, Sam Walton and his immediate legacy ensured that Wal-Mart was the place to shop if you wanted to pay the lowest price possible. This competitive advantage has diminished–not because Wal-Mart has lost the ability to bargain effectively with its vendors–but because Wal-Mart has reached for more profits when it sells those products to consumers at the same time that Kroger, Aldi, and Target have also increased their bargaining ability with vendors. As a result, there is some truth to the notion that Wal-Mart is currently trading on its past reputation for low prices and the current reality suggests a diminished moat as the low-cost producer.
Conclusion: Wal-Mart is currently being affected by the strength of the U.S. dollar abroad. But that is a cosmetic change to earnings, and doesn’t really speak to the fundamentals of operations unless you conclude that the U.S. dollar will perpetually gain in strength relative to a basket of global currencies. And the rise of Amazon compared to the sluggishness of walmart.com has also taken a bite out of Wal-Mart’s growth.
But the problems at Wal-Mart are much of their own doing. In attempts to meet quarterly expectations over the past ten years, it has incrementally abandoned its core mission to get shoppers the cheapest goods in an efficient manner. It has cut the availability of items, lengthened the checkout time, and tried to keep a little bit extra for the bottom-line on each item sold. None of these items are unfixable or a tragedy in their own, but collectively they explain how the forces of capitalism have taken some of the sizzle out of Wal-Mart’s long-term performance.