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Walmart Case Essay

1301 words - 6 pages

This paper is examining Wal-Mart Stores, Inc. and analyzing the value of its stock to make a buy/sell recommendation. The valuation is based on a variety of techniques to price the shares and then compare the intrinsic value with the currently trading market price: Dividend Discount model, CAPM, Three-Stage Approach and the Price/Earnings Multiple Approach. Executive Summary Founded by Sam Walton, Wal-Mart is the largest retailer in the world providing a huge assortment of merchandise, electronics, hardware and groceries at “everyday low prices”. 2010 Wal-Mart’s net sales were more than $405US billion. Wal-Mart had an initial stock price of $16.50/share in 1970. Since then Wal-Mart’s ...view middle of the document...

The beta of less than 1 shows that Wal-Mart is less volatile than the market. Beta of 0.66 is also in line with the grocery and food industry. Wal-Mart is providing affordable groceries for everybody. Food is a physiological need and is therefore located on the bottom of Maslow’s hierarchy of needs. People will always have to buy groceries, even in recession they are more likely to cut other luxurious goods or services back if the money is tight. Therefore Wal-Mart’s risk premium can be calculated as the product of beta times the Market Risk: . The expected rate of return (Ke) then is: . So for the current stock price (Po) we then get:

Therefore the DDM and the CAPM are valuing Wal-Mart’s stock higher than the recent closing price of $53.48. According to DDM, the Wal-Mart stock appears to be undervalued assuming the dividend growth, beta and MRP estimates are correct.

The Three-Stage Approach is dividing the future growth of Wal-Mart in three periods. Assumption for this model is that the abnormal growth years and transition years must total 17. This model is based on a lot of assumptions and input variables which are critically for the outcome price. The case and this report are assuming an initially growth in earnings of 23.3% which is in line with the geometric average of the Annual Earnings Growth % (in Exhibit 3), as well as a target cost of capital of 12%. The initial growth of 23.3% seems very high at first, but the case also mentions that there is an abnormal high growth expected in the next five years. Initial EPS is 2010s EPS of $3.72 times the geometric mean of 23.3%, which equals $4.59 (used as initial growth rate of EPS). I am also assuming 2010s payout ratio of 29.3% to be my initial payout ratio for the three stage approach, therefore the payout rate in the transition years only increases by 1.21%. I am assuming a payout rate of 45% at maturity.

Given all the assumptions above, the three stage approach is giving us a theoretical price of $127.87, which is a lot higher than the current closing price. Thus, Wal-Mart is undervalued. This report will include two additional scenarios: 1.) Let’s assume the initial growth rate of EPS is smaller than the geometric average (23.3%) due to economic circumstances such as recession. From 2009 to 2010 the EPS grow 4%. If we assume that it grows 4% from 2010 to 2011 as well, the input for the three stage approach would be 15%, which would change the outcome:

The different assumptions change the theoretical price drastically. According to the three stage approach with these modified assumptions, the theoretical price is $60.65, which is still more than the last closing price –...

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