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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