Why Wal-Mart Is Still a Compelling Investment

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Generally, I don’t like investing in retail stocks. Retail is incredibly competitive — unless you live in the middle of nowhere, it seems that you can’t go a fraction of a mile without coming across some retailer. As consumers, we have a plethora of choices as to where to shop. Furthermore, we’re pretty fickle: With very few exceptions, we don’t put very much thought into choosing one store or another, and decisions are often based on something as simple as convenience, a rudimentary knowledge of pricing, or the fact that a certain store pops up on an Internet search engine. Furthermore, if a company slips up even slightly, it could mean the loss of a large portion of its sales [e.g., J.C. Penney (NYSE:JCP)].

Therefore I tend to avoid retailers, and generally I believe that it is probably easier to find losers in this sector as potential short opportunities than winners as long opportunities. Whenever we do have clear winners, there are often issues of valuation. Consider the rich valuations of Michael Kors (NYSE:KORS), which trades at more than 30 times earnings, Whole Foods (NASDAQ:WFM), which trades at 35 times earnings, or Chipotle Mexican Grill (NYSE:CMG), which trades at over 50 times earnings. As a value investor I have a very difficult time paying these sorts of multiples for any company without an extraordinary reason.

However, one major exception to my anti-retail sentiment is Wal-Mart Stores (NYSE:WMT). As Wal-Mart’s recent earnings figures have been relatively weak, I think a lot of investors have lost confidence in this company’s ability to generate shareholder value. Nevertheless, Wal-Mart is arguably better positioned than any retailer with the possible exception of Amazon (NASDAQ:AMZN). As the world’s largest retailer, the company has an inherent advantage insofar as it can get the best prices on items to sell, and virtually every producer of consumer goods wants to sell their goods at Wal-Mart.

This puts Wal-Mart in a position of power in the asymmetric relationship between retailer and consumer product producer in nearly every circumstance. Wal-Mart has a bigger and better distribution infrastructure than any retailer, and this is why it is able to offer goods at such compelling prices relative to its competitors.

These are the benefits of being the largest retailer in the world. But what Wal-Mart is doing that is somewhat unexpected shows that it is incredibly versatile for such a large company: Wal-Mart is shifting its focus to smaller “neighborhood” locations that are designed for consumers looking for faster trips and smaller hauls. This strategy is working extremely well, as the company is reporting double-digit store growth. While we aren’t yet seeing this meaningfully impact the bottom line, Wal-Mart is showing investors that it can develop new ideas and implement them successfully, and as time goes by, we will see the full extent of the success of the smaller neighborhood shops.

Currently Wal-Mart is struggling, as are most other retailers. In the company’s last quarter, it was able to report a slight gain in revenues, but gross profits were flat, and net income fell by double digits. However, Wal-Mart, more so than virtually every other retailer, is positioned to survive this weakness, as its less-efficient, higher-priced competitors will ultimately suffer and lose market share to the retailer. I don’t expect to see an immediate turnaround in Wal-Mart’s business, but I think for long-term investors, we will see profits substantially higher in three to five years than they are today.

Technically, Wal-Mart has a very interesting chart. Wal-Mart’s stock has been one of the best performers to my knowledge over the past several decades. From the late 1970s through today, the shares have gained an unbelievable 95,000 percent in value, which means that $1,000 invested back then would be worth nearly $1 million today, without taking dividends into consideration!

The stock peaked at around $70 per share in 1999 and it consolidated for over a decade. Then, in 2012, it finally broke this resistance level, and the shares have basically been consolidating. This is a very positive sign and it suggests that the next move from here — $74 per share — is higher. The move may not come in the next few months, but the pattern appears to want to move higher in the next decade or so.

Wal-Mart has been a phenomenal long-term investment, and I think it will continue to be one going forward. It won’t offer the amazing returns that we saw in the 1980s and 1990s, but it should do very well. I think long-term investors with a low tolerance for risk may want to consider taking a position in Wal-Mart at around the $70 per share level.