U.S. stocks are higher on Thursday afternoon, with the Dow Jones Industrial Average (^DJI -0.11%) and the S&P 500 (^GSPC 0.02%) up 0.80% and 0.88%, respectively, at 1:45 p.m. EDT.
Sam Walton's original Walton's Five-and-Dime, now the Walmart Visitor Center, in Bentonville, Ark.
Image source: Bobak Ha'Eri. Republished under CC BY-SA 2.5.
In a paper published in the Journal of Finance in 1985, economists Richard Thaler and Werner de Bondt asked: Does the stock market overreact? Their conclusion: The stock market does indeed reflect people's tendency to "overreact to sudden and dramatic news." Is yesterday's 10% decline in Wal-Mart Stores' stock an illustration of Thaler and de Bondt's "overreaction hypothesis"?
First, let's start with the cause of the fall: During its investor day on Wednesday, Wal-Mart crushed Wall Street's hopes and dreams with a three-year "strategic framework" that included the following key projections:
- Earnings per share (EPS) to contract between 6% and 12% in the fiscal year ending in January 2017.
- Earnings per share to grow 5% to 10% in the year ending in January 2019.
Going into the meeting, analysts' consensus forecasts had EPS growing by 4% next year, so the new numbers had the same effect on investors as a sudden loss of hot water when you're taking a shower.
The following table summarizes the changes in the market's earnings assumptions based on pre- and post-announcement stock prices, Wal-Mart's reduced guidance, and a cost of equity of 8.1% (per Bloomberg):
|
Pre-Announcement* |
Post-Announcement** | |
|---|---|---|
|
Share price |
$66.73 |
$59.35 |
|
Share price decline |
-- |
$7.38 |
|
Loss in intrinsic value attributable to lower EPS guidance through fiscal 2019 |
-- |
$1.16 (16% of share price decline) |
|
Loss in intrinsic value attributable to lower EPS beyond fiscal 2019 |
$6.22 (84% of share price decline) |
|
|
Implied terminal EPS growth rate beyond fiscal 2019 |
0.14% |
(0.21%) |
*Closing price on Oct. 13. **Price at 12:00 p.m. EDT on Oct. 15.
Data source: Bloomberg, author's calculations based on data from Bloomberg and Zacks Investment Research.
The bulk of the drop in the share price is attributable to lower expected earnings beyond fiscal 2019. In other words, the market does not view Wal-Mart's announcement as a bump in the road that is contained to the next three years.
Instead, investors have also marked down their growth estimates for the remainder of Wal-Mart's operating life span. The implied earnings-per-share growth rate during the terminal period beyond fiscal 2019 has fallen from anemic growth of roughly 0.1% annually to a glacial decline of 0.2%.
Does it make sense to revise Wal-Mart's long-term growth rate down by roughly a third of a percentage point lower based on the new information the company provided?
It's not implausible, if one believes Wal-Mart's revised guidance reflects a quicker-than-expected shift in consumer shopping habits, away from big-box retailers and toward online merchants, for example -- that trend is not going away.
Ultimately, however, even if one makes the case that the market did overreact and the shares are now somewhat undervalued, it's difficult to get tremendously excited about Wal-Mart's shares due to pressures it faces in its home market (and its distinct lack of success in exporting its model internationally), except perhaps if one compares them to their peer group of large-capitalization stocks, which continues to look expensive.
