Is Wal-Mart Destined for Greatness?

Investors love stocks that consistently beat the Street without getting ahead of their fundamentals and risking a meltdown. The best stocks offer sustainable market-beating gains, with robust and improving financial metrics that support strong price growth. Does Wal-Mart (NYSE: WMT  ) fit the bill? Let's take a look at what its recent results tell us about its potential for future gains.

What we're looking for
The graphs you're about to see tell Wal-Mart's story, and we'll be grading the quality of that story in several ways:

  • Growth: Are profits, margins, and free cash flow all increasing?
  • Valuation: Is share price growing in line with earnings per share?
  • Opportunities: Is return on equity increasing while debt to equity declines?
  • Dividends: Are dividends consistently growing in a sustainable way?

What the numbers tell you
Now, let's take a look at Wal-Mart's key statistics:

WMT Total Return Price Chart

WMT Total Return Price data by YCharts

Passing Criteria

3-Year* Change

Grade

Revenue growth > 30%

13.6%

Fail

Improving profit margin

1.7%

Pass

Free cash flow growth > Net income growth

(17.9%) vs. 15.5%

Fail

Improving EPS

31.9%

Pass

Stock growth (+ 15%) < EPS growth

54.2% vs. 31.9%

Fail

Source: YCharts. * Period begins at end of Q2 2010.

WMT Return on Equity Chart

WMT Return on Equity data by YCharts

Passing Criteria

3-Year* Change

Grade

Improving return on equity

7.1%

Pass

Declining debt to equity

6.4%

Fail

Dividend growth > 25%

55.4%

Pass

Free cash flow payout ratio < 50%

48.8%

Pass

Source: YCharts. * Period begins at end of Q2 2010.

How we got here and where we're going
Wal-Mart got off to a wobbly start, hurt by modest revenue growth and declining free cash flow. However, the company continues to improve its bottom-line metrics, and might have earned more than five out of nine passing grades if not for a slight debt uptick, and investor enthusiasm that's just barely nudged shares beyond their fundamental growth rates. Let's dig a little deeper to see what Wal-Mart is currently doing to put together an even better performance next year.

Fool contributor Marie Palumbo notes that Wal-Mart had been trying to replicate Amazon's (NASDAQ: AMZN  ) e-commerce business model. However, Wal-Mart's online sales amounted to $7.7 billion, which is a rather tiny sliver of its gargantuan total revenue. The entire domestic online retail sector grew by 16%, to $224.3 billion last year, and Amazon is still managing to outpace that growth despite accounting for roughly a quarter of the entire take. Wal-Mart also has lofty plans to establish more warehouses, especially for processing online orders, from which it will ship products out of the excess inventory available in its stores. Wal-Mart has also been aggressively expanding its geographical presence in the international markets, and since Amazon's international presence remains modest, this could be a bigger long-term online opportunity for the retail giant.

Wal-Mart's entry into the Indian retail market could result in a long-term revenue driver, as it is a massive market with more than 1.2 billion people. My Foolish colleague Jeremy Bowman notes that the company has also advanced a proposal to operate supermarkets in India. Over in that other Eastern country with a billion people (China), Wal-Mart has bought 51% stake in Yihaodian, an e-commerce company, to scale up its online sales business. The company also has an ambitious plan to open 100 new stores in China over the next three years. Fool contributor Eileen Rojas notes that the Chinese retail market could reach $5 trillion by 2016. Even a 1% stake in that would be worth $50 billion to Wal-Mart's top line.

If Wal-Mart wants to win over foreign consumers, it might want to tidy up its image: the company has been accused of violating the Foreign Corrupt Practices Act FCPA in several countries. Authorities have launched investigations against Wal-Mart concerning international bribery allegations in Mexico, China, India and Brazil. Wal-Mart has already spent around $155 million to deal with the fallout.

Fool contributor Daniel Miller makes note of one image-rehab effort: the company has announced its intent to disburse low-interest $50-million loans to a number of factories in Bangladesh, after a building collapse in a garment plant killed over 1,000 workers in April. Despite these issues, Wal-Mart retains an unmatched ability to handle enormous sales and logistics challenges while remaining in the green.

Putting the pieces together
Today, Wal-Mart has some of the qualities that make up a great stock, but no stock is truly perfect. Digging deeper can help you uncover the answers you need to make a great buy -- or to stay away from a stock that's going nowhere.

The retail space is in the midst of the biggest paradigm shift since mail order took off at the turn of last century. Only those most forward-looking and capable companies will survive, and they'll handsomely reward those investors who understand the landscape. You can read about the 3 Companies Ready to Rule Retail in The Motley Fool's special report. Uncovering these top picks is free today; just click here to read more.


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