Why The Bearish Commentary On Wal-Mart Stock Is Overblown

  • Wal-Mart's P/E ratio hasn't been lower in the last 10 years. I expect this to revert to its mean.
  • Price to sales and price to book ratios have never been lower even though sales are still growing year on year.
  • Debt to equity ratio also demonstrates that Wal-Mart is not a value trap. The company has ample equity to overcome any potential problems that could arise.

Walmart (NYSE:WMT) is down over 30% year to date as many investors seem to have thrown in the towel since the company announced poor guidance for the next few years last month. However when a large cap (doing almost $500 billion in sales every year) loses 30% off its share price in a short space of time, I always get interested in it as a value play. There is always opportunity in "value plays" as the street usually exaggerates the pessimism associated with companies that are currently going through tough times. It's the same on the other end of the spectrum. Look at Amazon (NASDAQ:AMZN) for example, whose gross profit surpassed $26 billion last year but still has its net income in the red. Nevertheless Mr Market looks at growth rates and since Amazon's gross profit has increased almost 5 times since 2009, the street gives the company a high valuation. On the other hand Wal-Mart has projected that its earnings will stagnate or decline due to heavy investment in the next few years and as such, the stock has accordingly sold off. This to me provides opportunity as long as Wal-Mart fundamentals are still strong. Let's go through some ratios to find out if Wal-Mart is indeed a value play instead of a value trap.

The first ratio that is imperative when doing fundamental analysis is the price to earnings ratio. Wal-Mart currently has a p/e ratio of 12.62 and forward p/e ratio of 13.18. These figures are perfect for a value play in that they come under my limit of 15. Why 15 you may ask? Well stocks with low p/e ratios gives the company far more potential to be able to compound investor capital. Whereas the "herd" follow growth rates (which lead to higher stock prices and P/E ratios), astute investors look for sluggish growth because they know this will lead to downgrades from the analysts, which will tank the stock. Here is the situation with Wal-Mart regarding its earnings. Net income topped out a few years ago at $17 billion on $469 billion of revenues. This year the company is expected to report earnings of $15.5 billion on revenues of $485 billion which means margins are slipping (one of the most important forward looking metrics the street evaluates). On top of this, net income could fall further with wage hikes, e-commerce investment and re-modelling of superstores all keeping capex spending elevated. Elevated capex spend can upset long term Wal-Mart investors as cash flows (which affect buybacks and dividend growth rates) are always smaller when more money is being pumped back into the business. However value investors smell opportunity as the chart below confirms - Wal-Mart's P/E has never been lower in the last 10 years and the difference between its own p/e ratio the S&P 500's average has never been wider. I expect these divergences to revert to the mean in the future which will rally the share price.

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While the p/e ratio can sometimes be doctored by accountants because earnings change so much from quarter to quarter, the price to sales ratio and the price to book ratio sometimes are much better sounding boards to evaluate the valuation of a stock. Again when checking these metrics, they never have been lower over the last 10 years with the company's p/s ratio being 0.4 and the price to book ratio being 2.4. When these metrics are at historic lows, it implies that there is very little downside potential in the stock price. Income investors need to take a few extra steps to ensure the dividend (currently 3.3%). Currently the company's payout ratio is about 40% which is low and means there is ample room for the company to keep paying and growing the dividend. Furthermore income investors should look at the price to cash flow ratio which is currently 7.1. This again looks attractive (I look for value plays with price to cash flow ratios of under 10) so paying $7 for every $1 of cash generated implies plenty of upside in the share price from here.

However probably the most critical ratio when analyzing a potential value play is the debt to equity ratio and for good reason. This figure should be under 1 and preferably stable over the last few years. Many investors overlook this metric which is a fundamental flaw in my opinion because a low ratio protects against a downturn or the like. Wal-Mart's current debt to equity ratio is 0.54 and it is stable. Total liabilities are actually lower than 2013 whereas total assets are bigger than 2013 which explains the falling debt to equity metric over the last 2 years. In short, there seems to be no risk here to shareholders as the company is financially sound.

To sum up, I believe Wal-Mart stock offers an excellent value play at the moment. When you do the fundamental analysis on the company, you ascertain that its main metrics demonstrate that the stock is definitely not a value trap. Furthermore its e-commerce division is growing meaningfully and I can only see this division growing further from here when you consider the super stores it has on the ground - especially in the US. On the grocery front, which is the biggest revenue producer of Wal-Mart, I maintain it will not lose market share to the likes of Amazon as people prefer to do their fresh food shopping on their own (especially for fruit and vegetables). By concentrating in this area, Wal-Mart can win back lost market share.

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  • I do not have any business relationship with the companies mentioned in this post.
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