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Yesterday the Supreme Court began hearing oral arguments for a sexual-harassment Title VII claim, presently in the class certification stage, against Wal-Mart (WMT). This has given me a rare opportunity to apply some of my current legal education to stock analysis.

Wal-Mart: The Company

Wal-Mart needs little explanation. They are one of the largest companies in the world and sell basically any household need, from food, to electronics, to garden supplies. They have been around for quite some time and Sam Walton’s kids are some of the wealthiest people out there. Wal-Mart revolutionized "one-stop" shopping and through its size, was able to "rollback" prices, beating out the competition. They have over 8,000 units across the globe and another 600 or so Sam’s Clubs on top of that. As a company they have experienced great success.

This of course came with much criticism. The big one was that they were killing "mom and pop shops" and who’s to say if this was good for the economy. Yes, they put a damper on small businesses in the 1990s, but at the same time were offering a multitude of jobs and lower prices. Perhaps this increases consumer well-being to the point that it is more beneficial than the damage they have put on a few?

Then came claims that they were falling behind in in-store appearance. I noted in this article earlier this month that how Wal-Mart had to reinvent itself in order to keep up with Target (TGT). There were also the allegations that part of the company's success on the margins came from paying employees next to nothing, often busing in low-income legal aliens to work in their stores. The media did not take kindly to this (and rightfully so). Now they are in the middle of the largest sexual harassment claim in the history of U.S. law. There is more on that to follow but first we will look at the stock.

Wal-Mart: The Stock

Wal-Mart the stock is famous for two things: one good and one bad. The first is that they have been increasing the dividend annually for 35 years, as noted here. This puts them on any number of dividend lists; and their current yield of 2.8% is great considering it will be increasing for the next decade or so. It is for this reason that there is so much institutional ownership on WMT. Look at any large-cap dividend growth mutual fund holdings and it’s bound to be there.

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The knock on the stock is that the price has not gone anywhere in the last decade. It has traded between $40 and $60 since the turn of the millennium. Of course, the obvious refute to this is that earnings have been doing well in that time, dropping the P/E ration as seen below and the dividend payments have been increasing (and yes, I realize that means the yield was insignificant 10 years ago). The graph shows how the P/E fluctuations have fallen out of line with their price. It was inflated pre-recession, fell in line during, and has dropped significantly since. Since we know that the price has been relatively stable this means that earnings are increasing but people don’t like the stock itself.

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One of the paramount questions for WMT is: Is this lawsuit already priced into the stock? To which I would reply that is difficult to answer. They have recently dropped off from $58 to $52, but that could be for extrinsic reasons, like an earthquake and a war in Libya.

The Lawsuit

This suit is based off a complaint that picked up a number of plaintiffs coming forward with similar claims. The case is Dukes v. Wal-Mart Stores Inc. and the original complaint was filed on June 8, 2001. (Ironic that Wal-Mart’s CEO is Mike Duke; he makes $6 million in salary.) So, obviously the case has been jumping through hoops since then. Putting together a class action is very big business, but it can also be very time consuming. (For more on mass class actions, I would recommend John Grisham’s "The King of Torts." It’s thrilling and breaks all of this down.) Anyway, CNN has asserted that there could be upwards of 1.6 million plaintiffs with $10s of billions at stake. This comes from the fact that after a class is certified, additional plaintiffs may come forth and join said class.

Rule 23 of the Federal Rules of Civil Procedure sets four prerequisites that a class must meet before they are certified, and this is what is currently being argued before the court. The only issue is that the plaintiffs may be missing on the commonality requirement. Commonality means that they all have the same question of law. This is going to be questionable given the different employment statuses of the plaintiffs. But it could be reasonably argued that they are all going to question disparate treatment on the basis of sex, which is discrimination under Title VII of the Civil Rights Act of 1964, which created the EEOC.

The unfortunate thing for the class is that the court is going to let their political and personal views dictate this case before it even gets certified. The justices could throw this case out and the class will be left uncertified and the plaintiffs could then go and try to attack Wal-Mart on their own. This is the best case scenario for Wal-Mart, even with the public relations disaster that they endured the past two days.

With that said, this is likely. The three female justices, Ruth Ginsburg, Sonia Sotomayor and Elena Kagan, will most likely argue for class certification. I would expect them to be joined by Stephen Breyer. The most interesting thing here? All appointed by Democrats, Ginsburg and Breyer by Clinton and Sotomayor and Kagan by Obama. Not surprisingly, the opposing view will likely be spearheaded by ultra-conservatives Antonin Scalia and Clarence Thomas. Scalia is against almost anything liberal (gay rights, abortions and pro detainees in Guantanamo) and is probably not a fan of women’s suffrage either. Justice Anthony Kennedy was also apparently skeptical at granting the certification. These three were all appointed by Republican presidents (Scalia and Kennedy by Reagan and Thomas is the single remaining George Bush Sr. appointee). This leaves two other justices, both appointed by George W. Bush: Chief Justice John Roberts and Samuel Alito. I mention this because it's interesting. In the 2008 case of Boumediene v. Bush regarding Guantanamo, the Bush appointees plus Scalia were the four dissenters.

Given this, let’s assume the plaintiffs do not pass certification. What happens to Wal-Mart and more importantly, their stock: Does it go up? Perhaps, they would have just saved billions in compensatory and punitive damages. Lastly, the court won’t look to economic policy reasoning, but if the class did go through, imagine the rising cost of corporate sexual harassment insurance. Also there would be all sorts of new regulations imposed on all sorts of businesses. The foregoing analysis is part of the reason why I would advise picking up WMT now. They are cheap P/E wise, their dividend history is outstanding, and this lawsuit has probably priced them down by a few dollars.

Source: Why Supreme Court Case Should Have Wal-Mart on Everybody's Watch List