Recently I wrote an article about the "Stock Market Home Run Derby." Within this text I described how certain periods in the investment world - take early 2009 for example - are a lot like baseball's own "home run derby." That is, especially in hindsight, it would have been relatively easy to find a bundle of "home run" investments. I also expressed that in today's market it seems like these slow pitch equivalents are becoming more difficult to find. Yet just because an investment might not be a "home run" doesn't mean that an enormous amount of value can't still be had - particularly if one has a lengthy time horizon. In fact, within that article I mentioned that companies like Target (NYSE:TGT), Wells Fargo (NYSE:WFC) or Wal-Mart (NYSE:WMT) all seemed to fit into the "previously a home run, now a solid double" type of investment. So let's take a look at Wal-Mart and see what I mean by "solid double."
As we begin, I would like to explicitly indicate that this commentary should in no way be misconstrued as a purchase recommendation. Everyone is different with regard to their investing needs and goals. Rather this article should be considered as a baseline of thought, which might then be applied to a variety of other securities and scenarios. It's important to know why an investment personally works for you. In fact I'll demonstrate this point momentarily.
Warren Buffett Valuation
When talking about Warren Buffett's Berkshire Hathaway (NYSE:BRK.A) a lot of people like to talk about the "Big 4" securities: Wells Fargo, Coca-Cola (NYSE:KO), IBM and American Express (NYSE:AXP). Less often, people talk about some of the smaller yet still sizable holdings like U.S. Bancorp (NYSE:USB), ConocoPhillips (NYSE:COP) or even Wal-Mart. Nonetheless the same basic per share information can be derived. For example, in Berkshire's 2005 Annual Report [pdf] Buffett disclosed a nearly 20 million share ownership claim in Wal-Mart. Given a $944 million cost basis, this translated to buying WMT at a trailing P/E of 17.8, a current dividend yield of 1.27% and a payout ratio of 27%. Later in the 2009 BRK Annual Report [pdf] Berkshire disclosed an additional 19 million shares purchased at a per share cost basis of $49.81; equating to a 13.57 P/E, a 2.19% dividend yield and a payout ratio of 30%. Finally, from the 2012 Annual letter [pdf] one could observe an addition of roughly 16 million shares at a per share cost basis of $59.80 with a corresponding P/E of 11.91, a current yield of 2.66% and a payout ratio of 32%.
If we weight the three years of purchases, this loosely translates to Berkshire buying WMT at a blended P/E of 14.6, a current dividend yield of 2% and a payout ratio of 29.5%. Today Wal-Mart trades at a P/E of about 14.6, a current yield of 2.55% and a payout ratio around 37%. In other words, one could buy WMT at approximately the same valuation that Buffett has in the last few years. But it's not enough to know that Warren likes WMT for Berkshire at those metrics. In fact, I bring this valuation up for a very specific reason. Warren himself learned this lesson six decades ago in a conversation with Lou Green, a well-known investor of the time:
"[Lou] said to me, 'Why did you buy Marshall-Wells?'" "And I said, 'Because Ben Graham bought it,'" "Lou looked at me and said, 'Strike one!'"
So we know that just because WMT might be near a "Buffett valuation" that doesn't translate to a partnership decision for you. Although I would advocate that it doesn't hurt having this information. Perhaps we can get a clearer view of what I mean by "double investment" by using the F.A.S.T. Graphs tool:
Notice that I did not include the price line and instead simply included the business results of the last decade and a half. When you look at it, it's really something to behold. It's almost as if you were teaching middle school students how to draw the slope of a line and you wanted a real world example. Recession? What recession? With operating earnings growing at nearly 12% a year, the business performance of WMT delivered model-like consistency. Yet what happens when we add the price against the business results?
I think this graph does a great job of demonstrating why the price you pay matters. In 1999, based on an average high / low price, the market was pricing WMT at a P/E of 42. Think about that today. People might be arguing about whether Wal-Mart is sensibly priced at $75 or $65. If you use 1999 numbers, we're no longer arguing about that $10 difference, but instead deciding whether or not say $210 is a reasonable price. Now be honest, who here is willing to buy at that price? Yet look what happens to an investor's performance results even if they happened to pay 42x earnings back in 1999:
There's something to be said for a long time horizon and strong business results. Even after paying 42 times earnings one still would have seen a 5.2% annual compound gain. Granted due to the P/E compression this result greatly trails the business performance. But to me, it's still quite impressive considering the entry multiple. Further, I believe it enhances the thesis of "wonderful companies at reasonable prices." If you can get ok returns paying an unreasonable price, then it stands to reason that adequate or even above-average returns can be found by paying a fair price for a strong business. Today, WMT appears to be in the "fair price" camp. Here's a look at the F.A.S.T. Graphs estimated return calculator:
Based on an estimated EPS growth rate of 9.2% - which appears prudent given Wal-Mart's past performance and share buyback program - the estimator forecasts a 5-year annualized return of 12.1%. This is also based on a constant dividend payout ratio and assuming the market consensus is willing to pay 15 times WMT's future earnings. Note the wide band of additional possibilities and once again this is no way a recommendation. However, this is at the cusp of what I previously described as a "double" investment - both literally and figuratively. Figuratively you're not necessarily hitting it out of the ballpark, but then again 12% returns are certainly nothing to sneeze at. Literally a 12% average return for 6 years nominally doubles your investment.
By the way, as an ongoing very long-term investor I would actually prefer for WMT to trade sideways for the next decade with earnings and dividends growing at a robust pace. Now those chiefly concerned with capital appreciation might shy away from such an event. But show me a world where Wal-Mart trades at say a P/E of 6 and an 8% dividend yield and I'll show you a place that I wouldn't mind investing. That is, as long as the business remains fundamental and you paid a reasonable price, capital appreciation comes anyway. At sensible entry points a long-term investor can benefit from any price movement (or non-movement). It's the underlying business that you have to monitor.
Much like the Buffett example, even the ample F.A.S.T. Graph tool likely requires further "due diligence." However, I believe I've demonstrated the ideology that an investment doesn't have to be a "home run" in order to be worthwhile. In this particular case, if Wal-Mart can grow at a modest pace, continue to pay out less than half of its profits and people are willing to pay a sensible earnings multiple in the future (otherwise known as the triple threat) then one might literally and figuratively have found a "double" investment - not to mention an inflation-beating stream of income over time. If you ask me, finding a company that doesn't have to do anything that spectacular to reach a solid investment outcome is something in which I might find interest.