Reputable retailer walmart (WMT -0.24%) doesn’t need much introduction; it is the largest retailer in the world by revenue, and it has stores within 10 miles of 90% of Americans. It is part of the Dow Jones Industrial Averagean index of 30 of America’s most prominent companies.
People flock to familiar places when the going gets tough, and 2022 has been a tough year for the markets. That has made Walmart a popular name (as measured by the hot valuation of the stock right now). But can Walmart justify its hefty price tag?
Walmart’s low prices and sheer size make it a haven for consumers, but the numbers show it may not be a safe bet for your wallet. Here, shares can be traded over three years.
Losing ground to inflation
Walmart is a fascinating company; with annual sales of $611 billion, it is one of the world’s largest companies by revenue. However, it only generates $12 billion in cash flow on all those sales; the company sells its goods at the lowest possible prices to squeeze out competitors who are not big enough to match those prices.
But excessive inflation appears to be a threat; Walmart’s operating margin plummeted as inflation picked up in 2022. Margins fell from about 4% in 2019 to just 3.3% today, down 70 basis points (down 17%). It may not matter if Walmart was a technology company with thick margins. But since every basis point matters for such a wafer-thin business model, it hurts.
WMT Yield Data (TTM) by YCharts.
Turnover has grown by an average of 5% per year over the past three years, no mean feat for such a large number. However, you will see below that declining margins are more than offsetting sales growth, making profit the main focus.
Slowdown in earnings growth
When we look at the bottom line, the problems start to emerge; Walmart recently closed its fiscal year 2023 on Jan. 29 and released fiscal guidance for 2024. Earnings per share (EPS) is expected to decline from $6.29 per share in fiscal 2023 to between $5.90 and $6.05 in fiscal 2024. Falling profits pose two problems for shareholders.
First, falling earnings immediately make the stock more expensive. When valuing a stock based on earnings, such as price-to-earnings (P/E) ratio, investors divide the share price by EPS. A smaller denominator (EPS) causes the ratio to increase. Second, slowing growth (or falling earnings per share in Walmart’s case) makes it less likely that investors will pay a higher valuation for the stock.
Unfortunately, Wall Street does not expect a quick recovery for Walmart’s operating results. Analysts expect average annual earnings per share growth of 5% over the next three to five years. In other words, investors can expect the stock to return an average of 5% in annual price increases (plus 1.6% of the dividend), a mediocre return (assuming the valuation of the stock does not change).
What Walmart’s valuation means for investors
You might be disappointed if you hoped that Walmart’s valuation would position investors for better returns. It could be the opposite, with the valuation drag returns down Walmart’s already pedestrian growth prospects. Using management’s EPS guidance, the stock’s P/E ratio is 23; do declining earnings and potential low-single-digit earnings growth warrant that valuation?
Recall that the broader market, which over the long term averages 10% annual returns, trades at an expected P/E of 18; that is a difference of 27%. That could mean virtually no investment returns for years to come if Wall Street decides the stock earns a multiple comparable to the broader market. Does that mean it’s going to happen? I wish I had the crystal ball to tell you, but the data doesn’t look very promising.
If you’re looking for safe mid-single-digit returns, two-year government bonds are yielding 5% today. The US government guarantees the face value at maturity, so you don’t have to worry about volatility if you hold it. Walmart is an undisputed blue chip stock and one of the world’s most dominant companies; however, the valuation you pay matters when investing. Walmart’s current price doesn’t match the harsh realities investors are likely to face.
Justin Pope has no position in any of the stocks listed. The Motley Fool has positions in and recommends Walmart. The Motley Fool has a disclosure policy.