Wal-mart and Target Have the Worst Gross Profit Margin Among Peers

Wal-mart and Target have the lowest gross margin percentage among industry peers at 24.5% and 30%, respectively -- perhaps both companies are in need of a business model remodel.

Jan 21, 2014 at 6:30PM

"Strategy has been the primary building block of competitiveness over the past three decades, but in the future, the quest for sustainable advantage may well begin with the business model," said Ramon Casadesus-Masanell and Joan E. Ricart in the article "How to Design a Winning Business Model." Featured in the Harvard Business Review, the article provides an overview of what it takes for companies like Wal-Mart Stores (NYSE:WMT) to excel in highly competitive industries.

Gross margin: a measure of business model efficiency
Gross margin percentage is the first indication of profitability for a company. It is often used as a way to measure the effectiveness of a company's business model, especially within the same industry. As a result, investment analysts study trends in gross margin to gain clues about the early direction of company earnings.

Wal-Mart, Target (NYSE:TGT), Dollar General (NYSE:DG), Family Dollar Stores, Tuesday Morning Corp, Dollar Tree Stores, and Big Lots are all considered discount retailers, but it's hard to say which one is the better investment -- 2013 was a difficult year for most discount retailers. Let's compare gross margins to see if any trends emerge that can tell us which discount retailers to stay away from in 2014.

WMT Gross Profit (% of Annual Revenues) Chart

Wal-mart gross profit (percent of annual revenue) data by YCharts

Declining trends in gross profit margin
The average gross profit margin of the seven companies in this comparison, according to the 2013 calendar third quarter earnings report, is 32%, and Dollar General, Target, and Wal-Mart are the lowest -- these are the companies we'll focus on.

Dollar General had the third-lowest gross profit margin in the third quarter of 2013 at 30.3%, down from 30.9% in 2012. According to the earnings report, enhancements or opportunities exist in "category management, the expansion of private brand offerings, increased foreign sourcing, shrink reduction, distribution and transportation efficiencies and improvements to our pricing and markdown model..."

While there are clearly many opportunities for improvement at Dollar General, the company is second in same-store sales growth among the same list of competitors and is one of the few companies in the industry to post positive earnings growth. In other words, Dollar General has done a good job of finding the right balance between product cost and price. Prices are low enough to attract customers but high enough to make a profit.

Target has the second-lowest gross margin at 30%. Citing seasonal markdowns as the cause, Target's gross margin rate declined as well from 30.3% in 2012, according to the company's third-quarter report. Among its competition, Target is a great example of a "high-end" discount-retail business model. The model allows for fewer transactions because prices are higher. Indeed, transactions and units per transaction are trending down at Target, so the company pushed prices a little higher in the third quarter to compensate -- the only thing that's saving Target right now is pricing.

Surprisingly, Wal-Mart, the company that sells more in one year than the nominal GDP of Hong Kong, had the worst gross margin rate at 24.5%. If gross margin is a function of inventory costs, shouldn't Wal-Mart have a higher gross margin due to economies of scale? Something is very wrong with this picture.

The Foolish bottom line
While gross margin won't tell you which stocks to purchase, it can help to understand why a company is performing the way it is. It can also help to determine whether or not performance issues are temporary or structural.

What have we learned from analyzing the companies with the worst gross margins?

  • Even though Dollar General has a low gross margin, the company was able to strike the right balance between price and demand with its suppliers.
  • Target may have structural issues. The company suffers from low transaction volume but has a business model that allows for higher pricing. Without higher prices, Target's gross margin may have been even worse than Wal-Mart's.
  • Wal-Mart may also have structural issues. Like Target, the company suffers from lower transaction volume, but the business model doesn't allow for higher pricing, placing increased pressure on earnings.
  • Traditional business models may be challenged in the current economic environment due to increased competition and price inflation.

Dollar General appears to be a good pick despite the low gross margin percentage, however, Target and Wal-Mart have a few issues to work out -- the former can only raise prices so much and the latter can't raise prices at all. Both companies will need a business model overhaul to stay competitive in 2014.

Fool contributor C Bryant has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers