Please ensure Javascript is enabled for purposes of website accessibility

Is It Time to Go Bargain Shopping for Shares of Wal-Mart Stores?

By Alex Dumortier, CFA - Oct 15, 2015 at 1:58PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Did the market overreact to Wal-Mart's grim earnings guidance?

U.S. stocks are higher on Thursday afternoon, with the Dow Jones Industrial Average (^DJI 1.57%) and the S&P 500 (^GSPC 2.02%) 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.

Alex Dumortier, CFA 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.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Dow Jones Industrial Average (Price Return) Stock Quote
Dow Jones Industrial Average (Price Return)
^DJI
$33,287.76 (1.57%) $513.35
S&P 500 Index - Price Return (USD) Stock Quote
S&P 500 Index - Price Return (USD)
^GSPC
$4,205.60 (2.02%) $83.13

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning analyst team.

Stock Advisor Returns
373%
 
S&P 500 Returns
122%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 08/10/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.