Wal-Mart: A Tale Of 2 Returns

Oct. 20, 2015 2:37 PM ETWalmart Inc. (WMT)7 Comments
Eli Inkrot profile picture
Eli Inkrot
8.54K Followers

Summary

  • From 1999 through 2005, Wal-Mart, the business, performed quite well.
  • From 2005 through 2014 the business performed fine, but certainly not as well as it had.
  • Yet, investors saw returns that varied dramatically from the business performance over these periods.

In reviewing the history of long-standing dividend increasers, Wal-Mart (NYSE:WMT) probably wouldn't stand out to you. From 2005 through 2014, the company grew revenues by nearly 5% annually and total profits by about 4.5% per year. Due to a strong share repurchase program, earnings per share grew by 7.6%. As a result of a slightly lower end multiple, the share price climbed by 7% per annum. Add in dividends and you come to a collective total gain of about 8.5% per year.

Nothing about these numbers is particularly striking. It's not as if one set is abnormally high or another abnormally low. Four percent to eight percent business and investment growth, plus dividends allowed investors to see their wealth compound at an 8.5% annual rate. Here's what that looks like in table format:

WMT

Revenue Growth

4.9%

Start Profit Margin

3.5%

End Profit Margin

3.4%

Earnings Growth

4.5%

Yearly Share Count

-2.8%

EPS Growth

7.6%

Start P/E

18

End P/E

17

Share Price Growth

7.0%

% Of Divs Collected

25%

Start Payout %

23%

End Payout %

38%

Dividend Growth

13.8%

Total Return

8.5%

As you can see, everything is in a more or less "reasonable" range. The reduced share count allowed EPS to grow faster than earnings or revenue growth on the company level, but this was offset by a slightly lower margin and valuation.

This type of look makes a lot of sense. You would anticipate investment performance to track business performance over longer time periods. Yet, this doesn't always have to hold. Wal-Mart is a perfect example of this. If we look back six years prior to this observation period, it's easy to see what I mean.

Here's a look at the business and investment growth of the security from 1999 through 2005 and 2005 through 2014:

WMT 1999 - 05

WMT 05 - 14

Revenue Growth

11.4%

4.9%

Start Profit Margin

3.5%

3.5%

End Profit Margin

3.5%

3.4%

Earnings Growth

11.6%

4.5%

Yearly Share Count

-1.1%

-2.8%

EPS Growth

12.8%

7.6%

Start P/E

54

18

End P/E

18

17

Share Price Growth

-6.3%

7.0%

% Of Divs Collected

3%

25%

Start Payout %

16%

23%

End Payout %

23%

38%

Dividend Growth

20.1%

13.8%

Total Return

-5.5%

8.5%

If we're looking at the business metrics, Wal-Mart clearly did better from 1999 through 2005 as compared to the 2005 through 2014 period. Revenues grew by over 11% per year as compared to under 5% in the second period. Likewise, total earnings grew by nearly 12% in the earlier period as compared to just 4.5% growth in the second period. On the business front, the company was growing much faster in the earlier period.

Moreover, this carries through to some extent with regard to shareholder claims as well. Although the company did not retire as many shares in the 1999 through 2005 period, the earnings per share still grew at a much faster rate - nearly 13% per year as compared to under 8%.

The business of Wal-Mart was performing much better during the first period compared to the second period. Yet, just because this was the case, this certainly doesn't mean that the 1999-2005 investor fared better than the 2005-2014 investor. It reminds me of a Ben Graham quote: "Obvious prospects for physical growth in a business do not translate into obvious profits for investors."

At the turn of the century, it was obvious that Wal-Mart was having and would likely continue to have a great growth story. And the company delivered, effectively doubling already substantial profits in a six-year time horizon. Yet, this was also obvious to investors, which, in turn, resulted in a sky-high valuation.

At the end of 1999, shares were trading above 50 times earnings. That's the sort of thing that causes the stock performance and business performance to vary drastically. It's the sort of thing that Graham cautioned about.

Even though the business was humming along, eventually the earnings multiple fell. From over 50 times earnings to under 20 times earnings in six years. As a result, investors would have seen negative 5.5% annualized returns. Expressed differently, every $1 invested would have only been worth 70 cents six years later. And this wasn't because the business performed poorly - the business grew by double digits. And it wasn't because you ownership claim or cash flow had decreased - these steadily increased. The large negative return was solely a derivative of valuation; from investors becoming too optimistic at the start.

The second period is just as instructive. The business didn't grow as fast. Your underlying earnings claim would have slowed and the dividend growth rate would have been less. Yet, investors from 2005 through 2014 did substantially better than their 1999-2005 counterparts. And the reason is once again singular - the change in valuation wasn't as severe.

This is why valuation is so important. It's why prudent expectations and a long-term time horizon come up as important expectations in the investing process. Just because a business is likely to perform quite well, it does not follow that a security will mirror this result. Over the very long term, things more or less work out, but in the interim, you can have a wide divergence of returns.

Business results and investment results can vary dramatically. Wal-Mart's tale of two returns is a perfect example. From 1999 through 2005, the business performed just fine, quite well in fact. The problem was valuation. Moving from 2005 through 2014, the opposite was true - the business performance was less inspiring, but investor returns were much more reasonable. Keeping this type of example in the back of your mind can better prepare you for thinking about a long-term investment.

This article was written by

Eli Inkrot profile picture
8.54K Followers
Eli Inkrot is a writer. Check out his website: thecurrencyoftime.wordpress.com, his articles here on Seeking Alpha or his book - "You Don't Have A Money Problem" - on Amazon.com. Additionally, here is a quick bio: Eli has held the title of Vice President and Portfolio Manager at EDMP Inc. - a money management firm - along with Vice President for F.A.S.T. Graphs - a financial software company. Prior to that, he began his investment career as an analyst in private real estate for a public pension fund. During his time in real estate he was the lead for a variety of accounts with net asset values totaling nearly two billion dollars. Eli received a Master’s in Finance from the University of Tampa where he earned “highest honors” whilst receiving the distinction of being named the “most outstanding graduate student.” He also holds an undergraduate degree in Economics and Business Administration from Otterbein University, graduating “magna cum laude” with distinct honors in each major. During his tenure at Otterbein, Eli was a member of the varsity golf team, held the departmental Senator position for Business, Economics and Accounting and studied abroad in the Netherlands.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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