Buy The Dip: Wal-Mart Stores

In late August, we wrote that Wal-Mart shares were a bargain and today’s overreaction to management’s guidance presents an even better buying opportunity.

Photo Credit: Mike Mozart (Flickr)

WMT Price Already Implied Significant Profit Decline

At Tuesday’s closing price of $67/share, WMT had a price to economic book value (PEBV) ratio of 0.7. This ratio implies that the market expects Wal-Mart’s profits to permanently decline by 30%. Despite these low expectations, when management announced today that they expect earnings to fall as much as 12% next year, much less than what was already baked into the stock price, WMT fell nearly 10%. Such a negative reaction highlights how short-term focused the market can be.

Wal-Mart Still Has A Strong Business

Wal-Mart has a long history of navigating the ins and outs of the ever-changing retail industry. As we highlighted in our previous report, Wal-Mart has actually grown after-tax profits (NOPAT) by 9% compounded annually since 1998. While profit growth had been slowing as of late, the company still grew NOPAT by 3% compounded annually over the past five years.

Additionally, Wal-Mart has an impressive history of generating returns on the capital invested into its business, something many analysts must be forgetting in light of today’s announcements. Wal-Mart has generated a return on invested capital (ROIC) of 12% or higher in every year since 1999.

Lastly, over the past five years alone, Wal-Mart has generated over $56 billion in free cash flow. With today’s announcements, Wal-Mart is going to be putting its capital to use and create a stronger company.

Management’s Announcement Positions Wal-Mart For Future Profit Growth

While the headlines will trumpet that Wal-Mart’s earnings will decline year-over-year, the underlying decisions being made are aimed at positioning Wal-Mart to not only lead, but also win the retail battle. Far too often, people overlook the competitive advantages that Wal-Mart can extract from its store footprint and distribution systems. Today’s announcements look to strengthen these advantages in two ways: