After hitting a high of $91 per share earlier this year, shares of Wal-Mart (WMT) have retreated to the below the $60 mark today–trading at $59.37 at the time of writing. That gives Wal-Mart a 34% decline on the year. Given that Wal-Mart makes over $5 per share, the current valuation is between only 11x and 12x earnings.
The stock is now trading at a cheaper valuation than was available during The Great Recession when the stock traded at 13x earnings. The reasons for the cheap valuation has long been evident to long-term followers of the company: (1) it has 2,200,000 employees, and a significant percentage have received higher than usual wage increases in 2015; (2) the company generates 55% of sales outside the United States, and the strength of the U.S. dollar has understated earnings by over $0.30 on a constant currency basis; (3) we are six years into an improving economy, and Wal-Mart tends to deliver its greatest growth during unfavorable economic conditions when customers trade down a bit; and (4) the company only has 367 stores actually opening up in 2015 compared to the 600+ that are expected to open up in each year from 2016 until 2019.
The current yield of 3.3% is the highest starting yield you have ever been able to get on the stock. And yet, we are once again reminded of the short-term nature of many on Wall-Street. Five different banks have downgraded Wal-Mart, and yet the current consensus estimate remains unchanged at $7.20 per share for expected 2020 profits.
The only way a long-term investor can be intellectually consistent when advocating that a stock should be sold in response to a price decline would be if projected future earnings are lower. That’s not what banks like Citi, Credit Suisse, or JPMorgan are doing right now–they are telling you to sell the stock even while maintaining the same five-year earnings projections. That information is harmful to the long-term retail investor–if you agree with the projection that Wal-Mart will make $7.20 per share in profits in 2020, this is absolutely the best opportunity to purchase the stock in at least fifteen years.
I consider Wal-Mart’s fair value range to be around 15-17x earnings. If interest rates are low, and the business is performing well, I would see no problem paying 17x earnings for the world’s most giant retailer. And if interest rates or higher and/or the business is performing sluggishly, I would lower the valuation 10-15% or so to reflect that. If profits do reach $7.20 in 2020, then the stock would trade at $115 per share five years from now, plus you’d be collecting a 3.3% dividend that goes up each year.
The critics do have a point about near-term weakness. Wal-Mart is going to continue implementing raises next year, the dollar has a fair chance of remaining strong, and same-store sales growth may remain in the sluggish 1-3% range. It is entirely possible that, this time next year, the story about Wal-Mart will be exactly the same: Wal-Mart will have X number of issues that it needs to address, and the payoff for shareholders will be in the distance.
But I do not see that as a reason to avoid making an investment in Wal-Mart right now. Because stock market pricing is always forward looking, it can be an error to wait until business conditions improve before making an investment. When General Electric went back down to $25 per share, I read many comments to the effect of: “Well, the oil and gas divisions will probably take a few years to turn itself around, and the sale of the financial assets may take a few years to streamline.” And yet, the price of the stock has shot up 12% in the past month.
The same thing is happening with Chevron. People saw oil hit the $40s, and Chevron’s stock price dip into the $60s, and thought: “I’ll wait for oil to improve before buying.” Oil is still in the $40s, and the price of Chevron is now touching upon $90 per share. People make the mistake of trying to time their purchases to when business results change, inadvertently creating a lapsed opportunity by not realizing the greatest capital appreciation occurs when the perception of a company’s future direction changes.
What distinguishes Wal-Mart from Amazon is that it is executing a business model that works. Wal-Mart is going to make $15.5 billion in net profits this year. Less than two dozen other companies in the world can claim the same thing. Amazon has gained market share while losing money–promising to make up the margins later–but Wal-Mart does not have that “later” component—shareholders are collectively receiving $42.5 million per day in net profit.
Wal-Mart remains the only company in the world that is able to dictate terms to behemoths like Colgate-Palmolive, Procter & Gamble, and Smucker. The strength of their bargaining power is peerless, although Costco is starting to flex a similar muscle.
If you plug Wal-Mart’s returns into a calculator over the past ten or fifteen years, the results won’t be that impressive. The issue is that Wal-Mart traded at valuations like 40x earnings in 1999. And yet, the earnings of the company have increased by 10% annually when you include the company’s extensive buyback program over the past fifteen years. Plus, you collected an additional percentage point or two in the form of dividends depending on the past purchase point. The bad total returns have not been the result of poor long-term earnings growth, but rather, the result of a P/E ratio that has compressed from the 30 range to the current 11-12x earnings range.
A collapsing P/E ratio, coupled with earnings growth, may make the rearview window view look poor but it also corresponds to when the future is brightest. If you buy today, you get that 3.3% dividend. You will get to capture the full effects of earnings per share growth. And you are also going to get the benefit of P/E expansion, as the stock’s fair value will eventually drift towards the 15-17x earnings range. Wal-Mart stock in the $50s is not only an unusual buying opportunity because most large-caps are overvalued right now, but it is also unique among its peers in the Dividend Aristocrats Index for being a potential investment that satisfies two criteria: (1) 25+ years of dividend growth, and (2) likely P/E expansion ahead for the long term.
Originally posted 2015-10-15 13:42:39.
