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Goldman Sachs Group (GS) reduced its rating on Wal-Mart Stores Inc. (WMT) on Monday, partly because the retail giant has not been realizing returns on investments in its existing store base as quickly as the brokerage had anticipated. Still, Goldman points to several key factors, including structural and strategy changes, which could drive shares in the world's biggest retailer higher down the road. That would be in line with our analysis, which suggests Wal-Mart's stock has room to grow.

It's easy to see why some investors might be put off by Wal-Mart's share performance over the last year. The stock has barely budged, advancing just 3.3 percent while the average stock-price gain in the department and discount retail industry has been more than 13 percent. Wal-Mart's revenue and earnings growth have also lagged the industry average over the trailing 12-month [TTM] period, as indicated below.

WMT Growth

Against the backdrop of these lagging conditions, it should be no surprise that Wal-Mart is priced at a discount to the industry averages using several key valuation metrics such as price to earnings [P/E] and P/Sales.

WMT Valuation

Although Wal-Mart has faced some growth difficulties over the last year, it has managed to provide investors with industry-leading rates of return. For example, both return on investment [ROI] and return on equity [ROE] surpassed the industry norm in the TTM time frame.

WMT Management effectiveness

In a recent Reuters poll, 22 analysts provided earnings per share [EPS] estimates for Wal-Mart. Prior to the Goldman report, on average, these analysts expected EPS of $2.88 for the fiscal year ending January 2007, and $3.23 for fiscal 2008. This marks a slight upward revision from the consensus readings of $2.86 and $3.21 from a month ago. In Monday's report, Goldman lowered its already-below-average estimate for the year to January 2008 from $3.14 to $3.10. Yet, Goldman also pointed to potential for well-received management and strategy changes along with inventory productivity improvement among factors that could drive performance going forward. On average, analysts in a Reuters poll believe that Wal-Mart can post long-term EPS growth of 13 percent.

Our back-of-the-envelope analysis, which takes into consideration Wal-Mart's historical revenue and EPS growth rates, along with management effectiveness ratios and analyst estimates, suggests that the retailer's EPS can grow at a pace of about 12 percent. That easily eclipses the 9.7 percent annual pace for EPS growth our analysis suggests is needed to justify the current share price.

Disclosure: At the time of publication, Erik Dellith owned shares of GS. He did not directly own shares of WMT, though he may be an owner, albeit indirectly, as an investor in a mutual fund or an Exchange Traded Fund.

Note: This is independent investment and analysis from the Reuters.com investment channel, and is not connected with Reuters News. The opinions and views expressed herein are those of the author and are not endorsed by Reuters.com.

Source: Wal-Mart: Priced At a Discount With Room to Grow