Wal-Mart Vs. Target, Costco: Best Discount Store Stock

| About: Wal-Mart Stores, (WMT)

By Ron Hall

Historically, Wal-Mart (NYSE:WMT) has dominated almost every market in which it competes. Over 100 million people visit the discount store chain each week. Together they have helped make Wal-Mart the largest supermarket in the country, with annual grocery sales of $140 billion, representing roughly 25% of the $500 billion total market.

Wal-Mart divides its operations into three segments: Wal-Mart U.S., Sam's Clubs and Wal-Mart International. Last year, Wal-Mart U.S. generated sales of $264.2 billion, Sam's Clubs had sales of $53.8 billion, and Wal-Mart International had revenues of $129.9 billion, while additional sales of $3.05 billion came from the company's e-commerce site. All in all, Wal-Mart generated more than three times the combined revenue of its two main competitors: Target Stores (NYSE:TGT) and Costco (NASDAQ:COST). Target's sales were just $69.86 billion, while Costco's revenues brought in $88.92 billion.

However, all of that could soon change. Wal-Mart has been rapidly losing market share to Costco, as the latter moves to undercut the former's prices. In addition, Wal-Mart's recent issues regarding bribery are not going to help matters (read the story here). Wal-Mart is also facing a threat with regard to its e-commerce business as companies like Amazon (NASDAQ:AMZN) continue to grow in popularity. E-commerce only makes up about 1% of Wal-Mart's sales, so the effect is minimal right now. But as more customers turn away from bricks-and-mortar stores, the need to have a strong e-commerce presence is clear.

Wal-Mart recently traded at $62, with a market capitalization of approximately $203.49 billion. The company generated $446.95 billion in revenues during fiscal year 2012 and expects to see an increase of 5.1% during fiscal year 2013. Estimated revenues will be around $469 billion, with a 10% increase in international sales. The company operates more than 5,500 stores overseas, and 75% of these stores are located in developing countries.

Wal-Mart pays a dividend of $1.59 per share (2.70% yield). The company is also adding value to shareholders via its stock repurchase plan. Currently, Wal-Mart is priced at just 12.96 times its earnings vs. its industry's average of 15.7. This is a significant discount to the industry average as well as Wal-Mart's own five-year average P/E of 14.06. Wal-Mart earned $4.52 a share last year. That figure is expected to rise to $4.85 this year and $5.28 next year.

Historically, Wal-Mart is a strong company and I expect that to continue despite a weak economy. It also has a lot of hedge fund interest. Warren Buffett of Berkshire Hathaway, Boykin Curry of Eagle Capital Management, and Ken Fisher of Fisher Asset Management each owned large positions in the company at the end of the fourth quarter of 2011 (see Warren Buffett's top stock picks).

Rival Target is trading at $57 a share and is priced even lower at 11.70 times its forward earnings. It also offers a $1.20 dividend (2.10% yield), which is only marginally less than Wal-Mart's -- but it lacks the growth, least in the short term. Analysts are expecting Target to earn just $4.27 a share this year -- down one cent from last year's $4.28 -- and they expect that rate to rise to $4.85 next year. Based on these estimates and Target's current pricing, it looks like Target could make a great longer-term play. But investors buying in now will likely have to hold on to the stock for at least a year to realize a strong return, and the price of the stock could fall even lower between now and then.

Costco recently traded at $87 a share. The company earned $3.43 a share last year. Analysts are expecting that figure to rise to $3.86 a share this year, swelling to $4.37 a share next year. At this rate, the company is priced higher than its peers at 19.80 times its forward earnings. Premium pricing such as this is common when expectations are so high, but in this case so is the risk involved. Costco pays a 96-cent dividend (1.10% yield), but that will do little to offset investor losses if the company's actual performance falls short of analyst estimates.

Right now, I think that Wal-Mart is the best option -- especially in the short term. Its recent issues regarding bribery will hurt the company's share price, but buying low is the name of the investment game. I would wait until the price falls a little lower before making an investment in the company. I recommend buying in around $55 a share, and selling when the market rebounds or hold it as a long-term position.

Disclosure: I am long WMT.