Wal-Mart (WMT) is widely touted as a safe-haven stock with solid fundamentals. It certainly is a solid defensive stock with reasonable current valuations and a low correlation with the stock market. Investors should be picky when selecting other discount retailers to diversify their portfolios because most of them are richly valued. Instead, investors should consider stocks with low valuations and low market correlations from other industries. In this article, I will explain why Wal-Mart and Target (TGT) are two low beta stocks that should be in your portfolio now.
Today's Everyday Low Prices
There is no denying that Wal-Mart is a fearsome juggernaut of a company. Kantar Retail, a London-based research firm, found that Amazon's (AMZN) prices were 20% higher than Wal-Mart's based on a 36 items sample. Based on this research, Wal-Mart is cheaper than internet-enabled commerce. The same competition which is challenging Best Buy (BBY) is handily dispatched by the Wal-Mart behemoth.
However, if internet retail is the future of discount retail, Wal-Mart may be ill-equipped to fight back. Its corporate culture seems to repulse executive tech talent. Most recently, Venky Harinarayan and Anand Rajaraman, co-heads of its Silicon Valley innovation group, @WalmartLabs, announced they are leaving the company. This is the latest exodus of talent echoes Wal-Mart's earlier ecommerce key-person losses. Eduardo Castro-Wright announced he is retiring in July from his vice chairman position. He ran global sourcing operations along with the online business. Similarly, Wan Ling Martello left the company from his position as the executive vice president of e-commerce at Wal-Mart.
Wal-Mart lacks a compelling growth story. The loss of human resources casts doubt on Wal-Mart's ability to transition into electronic retailing. International growth may slow as the scandal of alleged bribery in Mexico and other foreign markets inspires government and internal crack-downs. In addition, flanking competitors leave little space for maneuvering or repositioning Wal-Mart's value proposition. Wal-Mart is getting squeezed by Target's low prices for better quality and various "Dollar Stores" offering lower prices for lower quality goods. There does not seem to be a plan to update or transform the stale Wal-Mart shopping experience. Wal-Mart's big-box format was impressive during the 1990's, but is cumbersome in the information age. Who wants to walk for miles when other store formats are more convenient?
There is also a question of negative brand image. Wal-Mart is perceived as being a rough employer and a cause of mass-extinction for small businesses in small towns. Regardless if this is true or false, good or bad, this is the perception many consumers have. Contrast this with Whole Foods Market (WFM) which can charge customers much more for what is essentially the same product. This consumer mindset latches on to confirming news of alleged bribery scandals and the negative environmental impact of Wal-Mart.
Based on these qualitative factors it is clear that Wal-Mart should trade at attractive valuations because it lacks an identifiable growth strategy.
At what price safe havens?
Neel Kashkari of PIMCO identified Wal-Mart as a buy in volatile times. He said they are "buying those names that we think have very strong fundamentals and more downside protection against some of the big macro shocks." The logic behind his arguments is that consumers "pinch pennies" in times of stress and flock to Wal-Mart and other discount retailers.
This reasoning is pretty much common knowledge. Based on high valuations, it appears that investors have bid up many discount retailers:
Family Dollar Stores
Most of these discount stores are not discount stocks! With the exception of Wal-Mart, Target, and Big Lots these firms are richly valued. Investors seeking defensive stocks in this industry should be selective and only consider Wal-Mart and Target because they afford low and moderate beta (market correlation) at reasonable price multiples.
Apparently the market is anticipating that consumers will flock to the inferior goods offered by many of these discount stores, and investors are bidding up their prices on this perceived safety. This consumer behavior is already "baked in" the stock prices of Costco, Dollar General, Dollar Tree, and Family Dollar.
At present prices most of these stocks offer another kind of risk: paying too much for a stock. Investors should be disciplined and avoid paying a premium for today's favored industries. With patience, they will be able to buy some of these names at lower valuations rather than pay price-to-earnings ratios in excess of 20 for a retail company.
With this in mind, stocks from outside discount retailers were screened for reasonable price multiples and low beta:
Education & Training Services
Fidelity National Financial
Surety & Title Insurance
Nippon Telegraph & Telephone
Property & Casualty Insurance
Apollo group, Fidelity National Financial, Nippon Telegraph & Telephone, and W.R. Berkley are diversified across different industries and offer low market correlations at attractive valuations. Notice that Apollo Group hails from the much-vilified for-profit education sector and that Nippon Telegraph & Telephone is domiciled in Japan where stock investing is unfashionable. These stocks demonstrate how buying cheap stocks often requires delving into unpopular categories. This is the investing version of shopping at discount stores which feature inventory close-outs.
Investors should consider these stocks along with shares of Target and Wal-Mart as components of a defensive stock portfolio. The resulting portfolio will have a low beta, industry diversification, and low price-to-earnings and price-to-sales ratios.