Wal-Mart Still a Winner
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In the 1950s, Charles E. Wilson, then head of
General Motors
, famously said, "What's good for General Motors is good for the nation, and vice versa." At the time, GM was the world's largest corporation and largest private employer. The iconic status GM once held in the American economy has long since faded. During the past 10 to 15 years, another behemoth has risen to take its place, and that's
Wal-Mart
(WMT) - Get Report
.
One could make the same statement about Wal-Mart today that Wilson made about GM a half century ago. It's dominant, it's powerful, it's huge. It should come as no surprise that Wal-Mart gets a thumbs up from such guru strategies of mine as Warren Buffett's, which places great value on a company having a dominant market position, and James. P. O'Shaughnessy's, which favors larger companies with steady performance.
With its more than 3,500 discount stores, supercenters, Neighborhood Markets grocery stores and Sam's Club membership warehouse stores; its $288 billion in revenue, about four times that of
Home Depot
(HD) - Get Report
, the second-largest retailer; and 1.5 million employees, Wal-Mart has become a steamroller that seems to be able to take on any and all competitors. Wal-Mart is now the largest toy retailer, CD seller and one of the top two grocery retailers. In just the past couple of weeks,
Winn-Dixie
, a grocery chain in the Southeast, went into bankruptcy and cited Wal-Mart as a major reason for its doing so.
The O'Shaughnessy strategy gives Wal-Mart a 100% rating, meaning it passes all of the strategy's tests, and the Buffett strategy gives it an 89% rating, just 1 percentage point below what's needed for a top-rated "strong interest" recommendation under that methodology. Wal-Mart's position in its market and the interest of these two guru strategies are, I think, reason enough for you to consider making Wal-Mart part of your investment portfolio.
The James P. O'Shaughnessy Strategy
James P. O'Shaughnessy's Cornerstone Value Strategy, based on my analysis of it, favors larger companies because of their generally solid and stable earnings. To be of interest, a company's market capitalization must be more than $1 billion. This is a test Wal-Mart easily passes, as its market cap is $225 billion.
Another of O'Shaughnessy's tests of size is sales. Trailing 12-month sales must be 1.5 times greater than the mean of the market's trailing 12-month sales. As already noted, Wal-Mart is big, so it has no difficulty beating the market's mean of $16.3 billion; Wal-Mart's sales total $288.2 billion.
The O'Shaughnessy strategy focuses on corporations that are better known and more highly traded than most; the logic is that these are more secure companies. It approves companies whose total number of outstanding shares is in excess of the market average's 624 million shares. Wal-Mart easily passes this test with 4.2 billion shares outstanding.
Size must be accompanied by a strong financial performance under O'Shaughnessy's methodology. This is measured by a company's cash flow. Target: cash flow greater than the market's mean cash flow per share. The market's mean is $2.40, while Wal-Mart's is $3.52.
The strategy's final step is to select the 50 companies from those that have passed the previous four criteria and that have the highest dividend yield. Wal-Mart, with a dividend yield of 1.1%, is one of the 50 companies that satisfy this last criterion.
The Warren Buffett Strategy
As mentioned above, the Warren Buffett strategy, based on my understanding of his approach to investing, gives Wal-Mart a high rating, but not quite the highest. First, I'll look at several aspects of Wal-Mart that appeal to Buffett's strategy, and then examine how it does not meet some of Buffett's criteria.
Wal-Mart is definitely a "Buffett-type" company: It is bigger than any of its competitors, is a household name, is more efficient than many of its competitors and enjoys enormous leverage over its suppliers, which allows it to be very price competitive while still maintaining its profit margins.
To maximize the chance that future earnings are predictable, Buffett's methodology requires solid, stable earnings that have continually expanded over an entire decade. Wal-Mart's annual earnings per share were 60 cents in 1995 and grew to $2.41 in 2004, increasing each and every year. Also, Wal-Mart's long-term historical EPS growth rate is 15.3%, based on the 10-year average EPS growth rate. The company is expected to grow earnings 14.1% per year in the future, based on the analysts' consensus estimated long-term growth rate.
Wal-Mart also scores well with regard to factors relating to return on equity. This strategy gives preference to an average return on equity of 15% or better, as this is an indicator that the company has a durable competitive advantage. U.S. corporations have, on average, returned about 12% on equity over the last 30 years. The average ROE for Wal-Mart, over the last 10 years, was 19.6%.
It is not enough that the average be at least 15%. For each of the last 10 years, ROE must be at least 10% for the strategy to accept that ROE is consistent. In addition, the average ROE over the last three years must also exceed 15%. Wal-Mart passes these criteria with ROE for the last 10 years of 18.5% in 1995, growing to 20.7% in 2004. The company's average ROE over the last three years was 20.1%, which the Buffett strategy considers a great return.
A consistently high ROE number is important not just in and of itself but because it is one of two ways that Buffett reasonably can project, 10 years out, how much shareholder equity will have compounded. When the equity per share is multiplied by a conservative price-to-earnings ratio for the company, it allows Buffett to forecast a future price per share and then to calculate, based on today's stock price, the rate of return an investor could expect on shares purchased at today's price. (A business calculator or spreadsheet easily can perform this calculation.) Generally, Buffet would like to purchase shares at a price where he projects by this method (as well as by a second method that I haven't gone into in this article) that he can earn 15% or more per year compounded. Based on Monday's closing price of $52.78, Buffett could expect a 15.7%-per-year return by this method.
Wal-Mart doesn't fare quite as well under the next couple of tests. The Buffett strategy likes companies that are conservatively financed. Wal-Mart has a debt of $23.7 billion and earnings of $10.2 billion, which could be used to pay off the debt in less than five years, thus passing this criterion. This is adequate, but the Buffett strategy prefers to see a company have sufficient earnings to pay off its debt in less than two years, which Wal-Mart could not do.
This strategy favors companies that do not have major capital expenditures, meaning they do not need to spend a ton of money on major plant and equipment upgrades or on research and development to stay competitive. Wal-Mart's free cash flow per share of minus 2 cents is negative, indicating the company is spending more cash than it is taking in. This is not a favorable sign according to Buffett's methodology, so this is one criterion the company fails. Note, though, that this really is a small difference from being in positive territory -- $120 million, or 0.8% of earnings.
Wal-Mart stumbled a bit this past November when it didn't discount prices for the holidays as quickly and deeply as some of its competitors. Don't let that fool you; Wal-Mart is doing well. It just raised its dividend from 13 cents a share per quarter to 15 cents, and has increased its dividend every year since it first declared one in 1974. Last week it announced that its U.S. same-store sales for March are on pace for growth of 4.1% over last year, a showing equal to what it experienced in February.
Wal-Mart, barely known to most Americans 20 years ago when it was focused primarily on rural and small-town markets, has become a genuine icon in corporate America. It is reviled and feared, admired and lauded. What General Motors,
AT&T
and
IBM
once were to the business world, Wal-Mart is today: large, powerful, enormously successful and seemingly unstoppable. Even if you don't shop at Wal-Mart, you can't deny that it is successful in the market spaces it aims at. For these reasons, and for the fact that two guru strategies favor it, Wal-Mart is a company well worth considering as an investment.
At the time of publication, Reese was long Wal-Mart, although holdings can change at any time.
John P. Reese is founder and CEO of Validea.com, an Internet investment research and stock analysis firm selected as one of Forbes Best 100 sites on the Web. He is also co-author of
The Market Gurus: Stock Investing Strategies You Can Use From Wall Street's Best
. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Reese appreciates your feedback and invites you to send it to
John.Reese@thestreet.com.
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