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Published: July 28, 2010
During the past decade, analysts have
collectively raised and lowered their rating on Wal-Mart
(NYSE: WMT) hundreds of times. Perhaps they shouldn't have
bothered. The stock has gone nowhere in 10 years, having been
mostly stuck between $45 and $60 for all of that time. But just
because the stock hasn't gone anywhere doesn't mean investors
can't make money from it. Some have profited handsomely by
knowing when to repeatedly enter and exit the stock. It's a
simple approach, though it involves a bit of math, which I'll
detail in a moment.
A different kind of growth stock
Wal-Mart has still been a nice growth story during the past
decade.
Earnings per share (EPS) rose by at least +10% from through
2003 to 2006, cooled a bit from that level in the next few
years, but rebounded to rise another +11% in fiscal 2010.
Analysts think profits can grow about +10% this year and next
year. Trouble is, Wal-Mart began the last decade trading at 70
times trailing earnings. So as profits have grown, the
P/E ratio has compressed and shares now trade for just 11
times next year's projected earnings.
Could that P/E ratio expand? Perhaps by a little bit. The
retailer
appears to be on the mend, taking market share in the
grocery aisle and in international markets. And as I concluded
recently, "if the multiple finally starts to move up to 12 or
13, then investors are looking at +20% to +30% upside. After a
decade of moving sideways, it may seem foolhardy to predict a
big run for shares of Wal-Mart at this point. But a combination
of rising sales, improved sourcing, tighter expense control and
a reduced share count make this mega-retailer poised to surprise
on the upside."
Wal-Mart's Real Yield
Indeed shares may move up, and you'll need to effectively gauge
when to take profits. You'll find no better gauge than
free cash flow, which is operating
cash flow minus capital expenditures. Since Wal-Mart is now
as large and stable as any company you'll find, look at that
free cash flow as a sort of proxy for the company's
income-producing capabilities. This is known as the free cash
flow
yield. (In this instance, Wal-Mart's dividend yield is not a
useful gauge, as the mega-retailer offers a fairly low payout).
Wal-Mart generated around $8 billion in
free cash flow in fiscal 2009, $9.9 billion in fiscal 2010, and
should see that metric rise to around $10.6 billion this
fiscal year. The entire company is currently valued at $190
billion, which means that the free cash flow yield ($10.6
billion/$190 billion) is about 5.6%. That's substantially higher
than "A"-rated corporate
bond rates, which yield 4.3%, according to valubond.com.
Wal-Mart is arguably more stable than most "A"-rated bond
issuers and is more akin to an "AA" or even "AAA"-rated issuer.
By this math, relative to corporate debt, Wal-Mart's equity is
quite attractive. The shares would need to trade up to around
$65 to be valued comparably. Investors can feel comfortable
owning shares at current levels, but be prepared to sell if they
move into the low $60s, making for a nice range-bound trade.
Action to Take -->
Wal-Mart's shares provide even more comfort at current levels
when you consider that sales are modestly growing and per share
profits are growing at an even faster pace, thanks to ongoing
massive stock buybacks.
This free cash flow exercise applies to virtually any large,
stable blue chip -- especially ones that aren't overly
economically sensitive. Try this exercise out on Dow stocks like
McDonalds (NYSE: MCD), Coca-Cola (NYSE: KO) or
Pfizer (NYSE: PFE) and see if the results are similarly
attractive.
-- David Sterman
Staff Writer
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