Toying Around With Wal-Mart

Santas everywhere may find both their gift bags and their wallets a little heavier now that Wal-Mart (NYSE:WMT) has taken to slashing prices for the holiday season.

No, I'm not suggesting that you fill the stockings of your kids and grandchildren with $4 generic pharmaceuticals. I am talking about Wal-Mart's latest announcement that it is rolling back prices on many popular toys and games.

Wal-Mart already slashed prices on consumer electronics and small appliances earlier this month. Now it is turning its attention to thinner markups on its playthings just as we head into the critical toy-selling holiday season.

Digging into the price cuts
Wal-Mart has historically worked off meager gross margins to begin with, as it prefers to sell at attractive price points and make it up in volume. The prospect of an even cheaper Wal-Mart shopping experience is tantalizing even to folks like me, who would rather pay marginally more at a Target (NYSE:TGT) than cross the path of a friendly Wal-Mart greeter.

However, I wanted to see if the toy rollback pricing was as generous as advertised, so I decided to compare a few items at Wal-Mart against the online storefronts of Target, Amazon.com (NASDAQ:AMZN), and Toys "R" Us (TRU).

Yes, Wal-Mart's got some pretty sweet deals, though it bears noting that many of the original prices were on the high end relative to the same item being stocked at rival stores.

Single out a random toy, like the technologically advanced Roboreptile that Wal-Mart is promoting on its toy-store landing website, and you see a $98.72 price tag -- not much cheaper than the $99.99 the same item will run you at Target or Toys "R" Us. In a welcome surprise, Amazon is the one that has its peers beat on that item with its $89.99 price.

And it is indeed a "welcome surprise," since just scouring through Amazon.com since Toys "R" Us left to launch its standalone site, I'm concerned for the online retailing behemoth. Its prices often appear to be on the high end, and availability can be spotty.

With the online toy merchants promoting free or highly subsidized shipping rates, this may be the ideal shopping season to cherry-pick and place your Internet orders through several storefronts.

Shopping tip for investors
What's that? You're an Ebenezer Scrooge at heart and have no intention of buying toys over the holidays? In that case, this is still an important event to monitor as an investor. I've read reports that claim that Target has more pricing flexibility here, because it can make up selling loss leaders in toys and electronics and in higher-margin clothing sales. Target's got that "cheap chic" thing going for it, and Wal-Mart apparel rarely gets high marks from thrifty fashionistas.

That's an incomplete assumption, though, because Wal-Mart has economies of scale and a lean infrastructure working in its favor. If the 2006 holiday shopping season does in fact turn into a full-blown price war, my money would be on Wal-Mart to be the one able to hold its breath underwater for the longest time.

This doesn't mean that Wal-Mart is the place to park your portfolio. If everyone is committed to razor-thin margins, even Wal-Mart's knack for turning over its inventory like a tornado funnel cloud may not be enough to provide the kind of growth that shareholders have been accustomed to in the past. As it stands, analysts expect the world's largest retailer to post just a 9.5% improvement in earnings per share over the critical holiday quarter. That's sequential deterioration from the 10.5% bottom-line growth that Wal-Mart posted for its October quarter yesterday and the annualized 13% growth rate that analysts are expecting out of the company over the next five years.

Wal-Mart's stock is currently priced at 15 times next fiscal year's profitability. That's certainly not pricey, given Wal-Mart's consistent production, but it's not as big a bargain as picking up the new updated Monopoly board game from Hasbro (NYSE:HAS) for just 15 bucks.

Cheaper toys mean cheaper toy stocks?
Speaking of "Here and Now," will the pricing war on toys that is taking place "here and now" hurt toymakers like Hasbro and Mattel (NYSE:MAT) later? Even if it's retailers bearing the brunt of this season's price cuts, we can't dismiss reality here. Toymakers have been making inroads into selling directly to consumers, and those prices will get pinched.

We also have behemoths like Wal-Mart that exert a great deal of pricing pressure on their suppliers. The company is the country's top toy retailer -- it overtook Toys "R" Us several years ago. If it dictates lower prices and the consumers perceive a lower value on playthings, margins will be tested at the toymaker level.

Does that mean that all of these lower prices will ultimately unleash the Grinch on related industries? We can hope not. Discount retailing and toy manufacturing are defensive industries that are built to last. However, keep an eye on the trends here, as things may get rocky.

Don't look a gift rocking horse in the mouth, but do look around for the price tag.

Amazon.com and Hasbro have been recommended to Motley Fool Stock Advisor newsletter subscribers. Wal-Mart and Mattel have been singled out as Inside Value stock picks.

Longtime Fool contributor Rick Munarriz has probably spent more at Wal-Mart's online store than at its offline empire in recent years. He does not own shares in any of the companies in this story. He is also part of the Rule Breakers newsletter research team, seeking out tomorrow's ultimate growth stocks a day early. T he Fool has a disclosure policy.