What About Wal-Mart?

Wal-Mart (WMT) is a controversial investment. In earlier blogs, I have analyzed some of this controversy: the union-generated smear campaign and the powerful WMT grocery business that threatens those unions. Yet the controversy is aided by the lagging stock price.

2006 was a good year for WMT operationally, but the investment community's response was tepid. While the overall market moved up nearly 15%, WMT's stock did not move up at all. Making matters worse, WMT's stock price has hardly moved up since 1999 - nearly flat for eight years. During that period, WMT's sales more than doubled, moving from $165 billion to $340 billion. Net profits also more than doubled, moving from $5.7 billion to almost $12 billion. In fact, the only operating metric to not double was the number of stores, which increased by 80%. This means that same-store sales and same-store profits increased nicely. So why didn't the stock move up?

Part of the problem was an excessive beginning p/e ratio. At the beginning of the period, WMT's p/e ratio averaged 39. (For the uninitiated, price to earnings ratios give me nose bleeds when higher than 20. 39 is ear-bleed territory.) Another issue is a slowdown in WMT's growth rate. However, WMT has periodically had low growth rates. So a fair question is "what should WMT's p/e be?"

WMT retains 80% of its earnings to build and buy stores worldwide. 20% of the earnings is paid out as a dividend. The retained earnings should grow by roughly 7% per year. In addition, there should be growth to at least cover inflation at roughly 2% per year. Finally, there should be some "real" same-store growth in profitability of roughly 2% per year. This overall 11% growth rate does not include the dividend. Without getting too technical, such characteristics probably deserve at least a 25 p/e - much higher than today's 16 p/e.

After spending years defending those not purchasing WMT, it feels odd to experience a complete reverse. The same arguments that were used for purchase, e.g. largest retailer in the world, high quality culture, top-notch systems, no longer have an effect. The numbers are huge. Over 100 million Americans shop at WMT every week; over 180 million do it globally.