High-Priced Wal-Mart?

By Keith Speights - June 13, 2012 | Tickers: COST, PSMT, TGT, WMT | 0 Comments

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Wal-Mart (NYSE: WMT) is known as the home of “everyday low prices.”  The company has achieved success for nearly 50 years by offering a wide selection of products at great values. The stock recently hit an all-time high. Yet at least one brokerage lists Wal-Mart as a “large cap value” stock. But is Wal-Mart actually priced at a value now or is it on the high end? Let’s take a look at both sides of the argument.

Expensive

Two main reasons that some people would say Wal-Mart shares are expensive right now are:

1. Stock at its high point
2. High price/earnings to growth (PEG) ratio

Let’s first quash reason #1. Wal-Mart stock did hit an all-time high recently and is trading near that high mark. But that means nothing in terms of answering the question of whether the stock is priced high or low. Sure, some stocks reach a high then investors begin to sell off. However, many other stocks set a record high only to go up much more over the next few months. Where Wal-Mart is in relation to where it has been in the past simply doesn’t help determine if the stock is valued attractively.

The PEG ratio is relevant, though. Wal-Mart’s PEG (using expected earnings over the next 5 years) is 1.66. The rule of thumb is that fairly valued stocks will have a PEG of 1.0. Based on this metric, Wal-Mart certainly shouldn’t be classified as a value stock. While share prices could still go up from this point, the PEG indicates that they are approaching the high end of valuation.

Value

We have to look hard to make the case that Wal-Mart is still a “large cap value” stock. Probably the best argument is how Wal-Mart compares against its peers in two valuation metrics – price/earnings and price/cash flow.

Wal-Mart’s primary competitors include Costco (NASDAQ: COST), PriceSmart (NASDAQ: PSMT), and Target (NYSE: TGT). Here is how the companies stack up.

Wal-Mart looks like a bargain compared to Costco and PriceSmart. Both companies are trading at significantly higher P/E and price/cash flow levels. However, Target has lower ratios than all the others, including Wal-Mart.

Is it possible, though, that Costco and PriceSmart are actually expensive? Yes, it is at least in the realm of possibility. For one thing, both stocks have higher PEG levels than Wal-Mart does.

Also, companies in the same industry can have different strategies that warrant having high or low valuations, irrespective of what competitors are doing. I personally don’t overly emphasize comparing peers because each company usually is at a different point in its growth.

Straddling the Fence

What is the real situation with Wal-Mart? I suggest that it is neither too expensive nor is it a bargain buy. Wal-Mart is probably priced just about what it’s worth.

Let’s assume that next year’s earnings will be somewhere between $5 and $6 per share. If we use 12.4 as the P/E multiple, which is in line historically for Wal-Mart, that gives us a range of $62 to $74 per share. With average analyst estimates of $5.34 per share next year, Wal-Mart’s current price of around $67 per share appears to be right in line with a fair valuation. It could go somewhat higher, but I wouldn’t look for any major surges.

Foolish Lessons

There are a few lessons that Foolish investors can learn from our little exercise. First, don’t believe a stock is a value just because you see a brokerage classify it as such. Brokerages can be, well, let’s just say factually challenged.

Second, the only thing that a stock hitting an all-time high means is that the stock has hit an all-time high. Nothing more and nothing less. The same principle applies to stocks that hit all-time lows.

Third, the best way to evaluate a stock is to look at the company itself more than its peers. That’s not to say that researching how other companies in the industry are performing isn’t a good thing to do. It is.

Finally, we shouldn’t assume that the stock of today will be the same as the stock six months from now. If we had looked at Wal-Mart right after the Mexico bribery scandal broke, the picture would have looked differently that it does now. The stock was much more of a bargain then.

Future events could put Wal-Mart back in the value column. Until then, we probably should take our stock shopping elsewhere. There are low prices every day - somewhere.

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