Wal-Mart Stores is one of the most successful growth stories in American history and can boast of an unparalleled track record of growth in nearly any measure one can think of. Whether your preferred metric is the number of square footage of retail space, sales, earnings, or dividend growth, a quick look at Wal-Mart quickly reveals an impressive trajectory that few others in retail can hope to match. However, as one looks at the statistics over the past ten years, it is clear that one measure has stagnated: Wal-Mart’s stock price. How could this be the case given Wal-Mart’s success over the past decade?
Solid Track Record: 1999 to 2008
Let’s take a quick look at Wal-Mart’s track record over the past ten years by examining the latest Value Line report on the company. (As an aside, it is possible to download all Value Line reports for companies in the Dow Jones Industrial Average for free at Value Line’s website.)
|Fiscal Year||Sales per Share||Div. per Share||EPS||Gross Margin||Net Margin||Store Count||Avg PE Ratio|
|Notes: Data from Value Line. 2008 Data uses estimates based on Value Line Publication Date of 2/6/09. Those interested in more precision for 2008 should reference Wal-Mart’s recently issued 10K. For purposes of this article, the exact precision for 2008 is not material to the point of the argument.|
These appear to be very solid results, particularly for a company that was already very large and well established in 1999. During this time frame, store count nearly doubled, gross margins actually improved, and net profit margins remained relatively constant.
Average annual compounded rates of growth for sales, dividends, and earnings per share are as follows:
|Average Annual Growth Rates: 1999 to 2008|
Wal-Mart’s Long Suffering Shareholders
Even a casual glance at the last column of the table showing the average annual Price/Earnings ratio shows that the market dramatically revised the valuation of Wal-Mart shares over this ten year period. Despite a decade of very satisfactory business results at Wal-Mart during which time earnings and dividends advanced in every single year, the price the market assigned to each dollar of earnings collapsed from 39.1 in 1999 to 16.5 in 2008.
Wal-Mart shares ranged from $38.70 to $70.30 in 1999 and from $43.10 to $63.80 in 2008. It is obvious that the typical shareholder who purchased Wal-Mart shares in 1999 is likely underwater despite collecting $4.81 in per share dividends over the last decade.
Overpaying for Growth
What explains the fact that buyers of Wal-Mart stock were willing to pay such a rich valuation in 1999? Part of it has to do with the fact that Wal-Mart’s progress in sales and per share earnings prior to 1999 was even more rapid and buyers of this stock were counting on continued growth in excess of 15% for earnings going forward. Despite a very satisfactory record over the past decade, Wal-Mart did not come close to what buyers of the stock in 1999 were implicitly assuming would occur over the coming decade.
This type of problem is common for “growth” stocks that reach the point where growth must inevitably slow down. Wal-Mart produced excellent business results over the past decade, but these results were not as strong as experienced previously. Market participants were projecting into the future growth rates that had been realized in the past without regard for the slowdown that inevitably occurs when a company reaches the size and scale of Wal-Mart.
In retrospect, the events described here may seem obvious and it is hard to believe that investors were willing to assign such a high market capitalization to Wal-Mart a decade ago. However, how can an investor separate real growth opportunities where it makes sense to “pay up” for current earnings in anticipation of rapid growth from maturing growth stories where an inevitable slowdown must soon occur?
One potential solution is to not get involved in “growth stories” at all. Obviously, doing so can result in missing some opportunities that investors may regret in the future. However, investors who are tempted to participate in this type of situation should at least consider what the market is pricing into a stock before making a purchase. In historical growth rates in earnings are 15 or 20%, is the company in question small enough to continue growing at such rates in the future, or is an inevitable slowdown approaching? Is there enough organic growth in the market to support expansion or will it be necessary to take market share from competitors? Even if growth is possible, can that growth come with the same margins that have been realized in the past?
These are obviously only a few questions to ask, and cannot fully protect against making future mistakes similar to a buyer of Wal-Mart stock in 1999. One sure way to avoid such situations is to refuse to pay high multiples of earnings on established companies under any circumstance. Wal-Mart was not alone in the late 1990s and there are many other examples of companies that have posted excellent business results over the past ten years while shareholders suffered with stagnant or negative returns.
Disclosure: The author does not currently own any Wal-Mart shares, but has held Wal-Mart shares in the past. No opinion is being given on whether Wal-Mart is attractive at today’s quotation since the purpose of this article was simply to review the experience of shareholders of Wal-Mart over the past decade.