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Wal-Mart (NYSE:WMT) was all over the news today over a leaked memo stating that they were off to the "worst start to a month I have seen in my ~7 years with the company." I first caught wind of this through Seeking Alpha's market current alerts, which if you're not subscribed to already, I highly recommend you do so. They are the best in the business for retail investors who want to know what is happening in the financial markets.

Looking at WMT's stock chart, they have had quite the run. Below is the 5 year, 1 year and year to date (YTD) performances:

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The big move was made back in May of 2012, oddly enough around the Mexican bribery scandal and the attempted ouster of CEO Mike Duke, but not surprisingly also around the announcement of a rollout of smaller stores. The Seeking Alpha market currents at that time captured all the action, another example of an opportunity in a crisis.

At that time, the rally was also cited as a "risk on" move, as the S&P 500 was falling at the same time and the concerns over the Euro crisis were close to their peak. Below is a chart with the S&P 500 (gold line) overlaid with the WMT graph (blue shaded region), on which I've circled WMT rise (red circle), the S&P 500's fall (green circle) and their shared fall in 2012 (grey circle). Rather than having a risk on, risk off relationship, that move appeared to be largely a one off, as the historical correlation between the two gives a reading of 0.62 (1 would be perfect correlation).

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The Fundamentals of Wal-Mart

Wal-Mart's income statement doesn't correlate with their recent price action. Since 2008, Wal-Mart's income has grown steadily but not at a rate that would suggest a price appreciation of over 50%. Below is a chart of their fundamentals, with the net income being the bottom bar chart, the revenue and costs being the above bar charts in green and red, and the pink line overlay being the price action of WMT.

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The balance sheet also doesn't substantiate the price run up, as it has also grown slowly but steadily since 2008.

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Looking at WMT ratios, it is trading at a P/E ratio (blue line) of 12.60, below its long-term average of 14.59, but also trading above its long-term average P/B ratio (green line) of 3.08 at 3.14. With these two indicators contradicting one another, there is no clear indication that this is a good value at which to buy in. Revenues have climbed steadily, with the occasional spikes being the Christmas quarter, but again not exponentially. The chart also demonstrates that the recent price run up actually brought WMT back in line with its long-term P/E ratio, likely the result of a lessening of concern for the US economy and consumer.

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After reviewing the fundamentals, it appears the discount that WMT was trading at post financial crisis has largely subsided, leaving little upside price potential in the stock.

A Positive Earnings Surprise Versus a Negative Earnings Surprise

With the leaked memo and the recent payroll tax increases, there will be an even greater focus on WMT's earnings, which traditionally serve as a barometer for the retail economy. Interestingly, the number to watch is not the earnings per share (EPS), but the growth in sales. Below are charts with the post announcement price action from a positive EPS surprise, a negative EPS surprise, a positive sales surprise and a negative sales surprise:

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The white line is the average in all cases, and the only time there is positive price action post announcement on average is when there are positive sales. Also of note is the asymmetrical payoff of WMT post announcement, as in both the positive cases there is a split in the price action, but in the negative case, the price action is consistently negative.

Based on this, if you're speculating on the announcement, it is best to speculate on the short side.

WMT Put Option Price Action

Information is contained in prices, a remarkable amount in fact, and there is a tremendous amount of information contained in option prices in particular. This is due to the fact that they are largely traded by sophisticated investors, providing a glimpse as to what the "smart money" is position for.

With the downside bias post announcement, plus the recent news, one would expect option volatility to have spiked, and indeed it has. Especially around the March 2013 level, which is demonstrated in the following 3D grid:

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Don't be intimidated by the fact that this graph is 3D, it is demonstrating a simple relationship between option strikes, expiries and demand. In the bottom right axis are option expiries, starting at March 2013 and ending at Quarter 4 in the year 2022, on the bottom left are the strike prices, starting at 47.5 and ending at 100, and the vertical axis is the option volatility, with the higher volatility being indicative of higher demand for options at that strike. I've highlighted the March 2013 47.50 strikes, as you can see there is a massive skew in volatility around that strike.

In addition, the intraday pricing of the $67.50 strike put option reflects today's negative news, with the implied volatility and price rallying sharply at noon today, when the news broke.

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Hedge Fund Managers Have Sold Their Shares

Hedge fund managers look to have caught much of the rally in 2012 with holdings of WMT reaching their highest point in 2 years at the end of 2012. Keep in mind that these numbers are reported after, rather than when, they purchased the stock. Although in the graph below it shows the purchases ramping up in September and August, they likely purchased shares prior to then:

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Since the recent rally, hedge funds have sold their stake in WMT, with their holdings as a percentage of publicly reported holdings at the lowest point in two years.

The Bottom Line

I consider WMT to be one of the greatest companies on earth. They're a key reason why the human species is living better than it ever has in its 100,000 year history, as higher standards of living are driven by higher rates of productivity, which WMT has contributed greatly to.

That being said, in light of the recent memo, the new payroll taxes, unspectacular financial fundamentals, option price action and hedge fund positioning, if you were fortunate enough to participate in the rally that began in 2012, it may be time to take those winnings off the table and find better opportunities for your capital. With earnings right around the corner and with negative price action being the most likely outcome based on past price action, it'd be better to sell before the earnings announcement rather than later.

Source: Sell Wal-Mart Prior To February 21st Earnings