U.S. retailer Walmart (WMT -0.08%) is an American icon. It's one of the largest companies on Earth, and an estimated 90% of U.S. consumers live within 10 miles of a Walmart store. Additionally, the company, which already has decades of consecutive dividend growth, just hiked the payout by over 9%, a sign of management's confidence in Walmart's prospects.
So, why is Walmart poised to underperform the broader stock market over the next five years? As Warren Buffett once said, "Price is what you pay, value is what you get." Walmart may have built its dominance by providing unbeatable value to shoppers, but investors aren't afforded the same value today.
Sentiment toward Walmart is sky-high
There's nothing controversial here. Walmart is a Dividend King and a great business. It has size and leverage with vendors that arguably nobody else does, meaning it can sell groceries and goods for less than anyone. But a great business can be a lousy stock when everyone already loves it. That's what is happening here.
Today, Walmart trades at all-time highs, and its resulting valuation is nearly 25 times its estimated 2024 earnings:
WMT PE Ratio (Forward) data by YCharts
There are some problems with Walmart trading at such a high valuation. First, it likely won't grow fast enough to justify such a high price tag forever. Analysts believe Walmart will grow earnings by an annual average of roughly 7% over the next three to five years.
To put this in perspective, I like using the price/earnings-to-growth (PEG) ratio, which compares a stock's valuation to how fast the underlying business grows. Generally, I look for PEG ratios of 1.5 or less. Walmart's current PEG ratio is 3.5, which means the stock could fall 50% in value and still wouldn't necessarily be cheap.
What the next five years could look like
A high valuation alone isn't the problem because a company with rapid earnings growth often commands a premium that it can grow into. But Walmart, a huge company doing hundreds of billions of dollars in sales and locations everywhere in the United States, will have a harder time catching up to the stock's hot valuation.
I'll outline the danger of overpaying below. Suppose I project Walmart's future earnings. Analysts are estimating 2024 earnings per share (EPS) at $7.02, and I've put years 2025-2028 below, using a 7% growth rate reflecting analysts' long-term estimates:
| Year | Estimated EPS | Resulting P/E Ratio |
|---|---|---|
| 2024 | $7.02 | 25.0 |
| 2025 | $7.51 | 23.3 |
| 2026 | $8.03 | 21.8 |
| 2027 | $8.60 | 20.3 |
| 2028 | $9.20 | 19.0 |
Calculations by author.
Assuming Walmart winds up performing along these lines, investors are highly vulnerable to a lower valuation that would cripple returns. Could Walmart's P/E ratio slip to 20 or below? Easily. The stock traded at 20 times earnings back in July 2022. In that scenario, investors are looking at virtually dead money for the next four or five years because the dividend yields just over 1%, so you're not getting much there.
The S&P 500 historically averages 9% to 10% returns in a given year. Walmart will have to grow far faster than analysts expect, or the valuation will have to stay in the stratosphere for the stock to keep pace with the broader market. It just seems very unlikely.
Here's the bottom line
Walmart is truly a blue chip stock, but investors can't buy the stock at any price. The stock doesn't make sense at its current valuation, and investors are likely in for some pain if the market begins backing off the premium valuation shares are enjoying today.
Investors shouldn't necessarily sell the stock. There is merit to holding winning stocks indefinitely, especially if you're already sitting on significant gains. But those who are pondering buying shares today should heavily reconsider.
