Walmart (WMT): Part Five - Sideways Action Deflates the Value Balloon

In its fiscal year 2003, Walmart generated about $7 billion in earnings that went to the benefit of its equity owners. It paid a modest dividend, plowed the rest back into the business, and then borrowed another $3.8 billion to invest even more into its growth.

It was good times for the world’s biggest retailer. The company’s market cap hit $283 billion – more than 40x those $7 billion in owner earnings – revealing investors’ enthusiasm about the business; about their belief that it was going to grow and grow and grow.

And grow it did. Revenue has jumped from $247 billion to nearly $422 billion. It has reinvested over $90 billion to build new stores, strengthen its already formidable distribution and technology edge, and expand internationally. And those owner earnings have compounded at a rate of 13.5% each year since 2003, reaching $18 billion this most recent fiscal year, 2011.

Surely those investors who saw their digital certificates of stock blink up to $63.75 in 2003 have made out like bandits, riding the impressive operating results wrought by Wal-Mart’s management over the decade. Right?

No.

As I write this, Wal-Mart’s market value is about $181 billion. That’s right. Despite years of business expansion, compounded owner earnings, dividends paid, and shares repurchased, the market value of the company is 35% less now than it was then.  Does this make sense?

Well, yes. It pretty much does.

Paying 40x owner earnings for any company is hard to justify. Wal-Mart, the great business that it was (and is), was overpriced.  What tends to happen in these cases is one of two things.

One, something about Wal-Mart’s operating performance, the stock market in general, the world economy, etc. spooks investors and sends them running for the exits, popping the inflated balloon that was Wal-Mart’s stock price.  This is common for hot “growth” stocks where the value depends on optimistic (nay, drug-induced?) assumptions of their continued growth. When circumstances no longer allow speculators to delude themselves, they panic and send the stock price into a nosedive with their selling. Don’t be surprised when you see this happen to…salesforce.com (CRM) selling at 191x its net earnings, Dunkin’ Donuts (DNKN) selling at 179x, or even a powerful force like Amazon.com (AMZN) selling at 83x.

Two, investors avoid an overreaction, but let the air out of the balloon one small deflating puff at a time. There is no panic, but no new buyers emerge for the stock at the high valuation and existing owners – perhaps realizing this, or perhaps recognizing that they bought too high, or perhaps from boredom that the stock price isn’t moving – start a slow sell. Though it lacks the excitement of a pop, the air just gradually seeps out. 

For owners of Wal-Mart at $63.75 in 2003, the process has been slow and excruciating. Things have just gone sideways for over eight years. The high multiple of owner earnings at which investors have been willing to buy the stock in any given year has drifted from 40x to 37…31…23…16x. And today, with a price hovering around $50 per share, Wal-Mart is trading at about 10x its fiscal year 2011 owner earnings of $18 billion (give or take).

So, the question becomes, is Wal-Mart now an attractive opportunity for new investors?