Based on the recent performance of Wal-Mart's
Clearly, Wal-Mart's steady sales and earnings growth have not translated into strong stock returns in recent years. Wal-Mart's sales averaged 11% annual growth over the past five years and earnings per share increased by more than 15% per year. Wal-Mart's stock, on the other hand, delivered a total return that averaged -3.3% over the past five years. While this disconnect between positive operating performance and negative stock performance might at first suggest a good investing opportunity, close analysis reveals some critical flaws that would seem to justify Wal-Mart's sluggish stock.
Wal-Mart's growth has been costly. The company has been opening new stores at a compounded rate of 10% per year and now has over 4,000 stores in the United States alone. That level of expansion has contributed to the significant decline in the rate of same-store sales growth, which had averaged a solid 5% annually over the past 10 years, but recently slipped to just 2%-3% per year. In the company's most recent 10-K filing, Wal-Mart's CEO acknowledged that cannibalization has become an important concern for management, but the company has nevertheless committed to plans to open more than 600 new stores this year. By comparison, Wal-Mart's smaller rivals Costco
Wal-Mart has been looking abroad -- often to less developed markets -- to help satisfy its growth ambitions, but the Wal-Mart experience does not always export well. In just this past year, the company decided to discontinue its German and South Korean operations, taking a loss in the process. Wal-Mart's continuing international operations generate slightly lower operating margins than the company's U.S. units, and the international units' asset turnover ratios have been significantly lower than for the company overall. These lower measures of profitability and operating performance help explain why Wal-Mart's returns on invested capital have been declining.
The declining productivity of incremental investments would be easier to forgive if Wal-Mart's competitive position were improving. Unfortunately, the company's low-cost advantage has been eroding as rival firms have become more efficient. In addition, Wal-Mart has failed to develop an effective strategy to dominate higher-margin categories like apparel and home furnishings the way it dominates lower-margin categories like consumer staples. Instead, the company seems to lurch from one ill-conceived marketing strategy to another, while its rivals execute consistent marketing and merchandising strategies that resonate with customers who seek higher-quality products and a better shopping experience.
At a recent price of $47, Wal-Mart shares trade at a multiple of just 16 times earnings. That price may at first seem like a bargain, but multiple expansion that would lift Wal-Mart's share price is unlikely to occur while the company's profitability, operating performance, and competitive strategy remain under pressure. Of course, these are manageable issues that many companies face when they mature, but Wal-Mart's management seems unwilling to adjust to the company's new realities by slowing the rate of expansion. Management's tendency to continually generate negative publicity is another problem that will likely continue to depress its share price. (Doesn't it seem like there's always some new allegation directed at Bentonville about the aggressive tactics the company uses against its opponents?) Investors looking for a stock that will outperform the market would be well-served to keep looking.
Wal-Mart is a Motley Fool Inside Value recommendation. Costco is a Motley Fool Stock Advisor selection. Two great companies, two great newsletters. You can why with a free 30-day trial. Fool contributor Michael Leibert welcomes your feedback. He does not have a position in the shares of any of the companies mentioned above. The Fool has a disclosure policy.