Wal-Mart looks good value right now, with its price to sales ratio having an imbalanced upside/downside profile.
It is currently towards the bottom end of its two-year price to sales ratio range, which we feel indicates the stock price could firm up.
The current valuation gap between Wal-Mart and Costco is too narrow and we may have entered an expansion phase that will be good news for investors in Wal-Mart.
Wal-Mart Price To Sales Ratio
As you can see from the chart below, Wal-Mart's (NYSE:WMT) price to sales ratio has ranged between 0.502 and 0.568 over the last year. It reached those two levels in November 2013 and February 2014, respectively, with the ratio currently standing at 0.518. This is towards the lower end of Wal-Mart's one-year price to sales range, with it being just 3.2% higher than the low point. It is currently 8.8% below its one-year high, which shows that there is more upside than downside potential within the one-year range.
What really interests us about the chart below is the last two years, during which time Wal-Mart's price to sales ratio has ranged between 0.49 and 0.568. Indeed, it has touched its low point twice (first in early 2013 and second in early 2014) and it appears to us as though this could be a support level, since on both occasions it has gone on to higher levels in the months following the movement. Although Wal-Mart's price to sales ratio is currently 5.4% away from the support level of 0.49, we think that there is limited downside to the support level, with there being upside to the top of the two-year range of 0.568. That level is 9.7% higher than the present price to sales ratio.
Furthermore, Wal-Mart's price to sales ratio has rarely remained close to its support level for long over the last two years and can move upwards at a fairly fast pace, as shown on the two prior occasions when it was at or near its support level in early 2013 and early 2014. For instance, it was 0.49 in February 2013 before moving up by 15.9% within three months. Likewise, in January 2014 it was at 0.495 before it moved up to 0.546 - a gain of 10.3% in around 5 months. Although not quite at the support level right now, we feel that there is scope for Wal-Mart's price to sales ratio to move upwards going forward.
We also feel there is upside potential as a result of a fairly narrow gap in the price to sales ratio of Wal-Mart versus sector peer, Costco (NASDAQ:COST). As the chart below shows, Wal-Mart has had a higher price to sales ratio than Costco throughout the last five years. However, what we're fascinated by is the gap between the two. Five years ago, the gap was at its widest point, with Wal-Mart having a price to sales ratio that was 58% higher than that of Costco. The gap then narrowed to practically zero by late 2011 before extending so that Wal-Mart's price to sales ratio was 35% higher than Costco's in late 2012.
Since then the gap has again narrowed, with it being just 9.5% at the moment. We feel that this margin is too small and that it has already begun an expansion phase, since the gap narrowed to just under 6% earlier this year. As such, we think that there is scope for Wal-Mart's price to sales ratio to expand relative to Costco's, as the market realizes that the margin between the two companies' valuations has become too narrow by recent historical standards. This realization, we feel, will cause Wal-Mart's valuation to firm up going forward.
We feel that Wal-Mart represents good value for money at current price levels. Not only is it trading towards the bottom end of its one-year price to sales ratio range, it is also close to its two-year support level. We believe there is, therefore, limited downside, more potential upside and that the market will react positively to what appears to be an attractively priced stock.
In addition, Wal-Mart's valuation gap versus sector peer, Costco, has become too narrow in our view. While the difference between the two has been smaller in the recent past, we think that there is limited scope for it to narrow further, but there is much greater potential for it to expand going forward. As such, we're bullish on Wal-Mart and believe that it is only a matter of time before investors latch on to what appears to be an undervalued stock and market forces subsequently bid up its price.
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Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.