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Stocks  | October 21, 2019

The Walmart (NYSE:WMT) stock price has risen 28% so far in 2019, reaching a new all-time high. But the rally of Walmart stock doesn’t yet seem justified by the performance of its business.

Indeed, Walmart’s growth this fiscal year, even after it raised its guidance a few months ago, hardly looks impressive. The company expects its annual earnings per share, excluding certain items, to be little changed versus last year’s EPS.

Losses from India’s Flipkart, in which Walmart acquired a majority stake last year, are hurting its bottom line. Excluding those losses, the company’s post-Q2 outlook suggests “mid-to high single-digit percentage”growth of its EPS for the full year.

Still, Walmart stock is trading at about 24 times that EPS guidance. That’s the stock’s highest earnings multiple in at least a decade. And it can be argued that 24 times earnings for 8% or so growth is too expensive.

In fact, I’ve expressed some skepticism towards the current valuation of Walmart stock. And I still don’t feel compelled to buy WMT stock. But the case for buying Walmart stock at $120 is stronger than its headline earnings multiples might suggest. Still, buying WMT stock at its current levels requires trust not only in the company, but in the American economy.

WMT Has Become a Better Company

The bullish view of WMT stock is that Walmart simply is a much better company than it’s been in years. Its grocery business has been re-energized, and clearly has taken market share from the likes of Kroger (NYSE:KR) and Albertsons. Kroger is guiding for same-sales growth excluding fuel this year of 2%-2.25%. Based on Walmart’s outlook.its U.S. business should come in closer to 3% growth,

Meanwhile, Walmart has moved heavily into e-commerce, both through acquisitions and by expanding its own online business. Walmart’s Marketplace is becoming a serious rival to (NASDAQ:AMZN).

And WMT seems to have finally cracked the code of the online grocery business, which had been a graveyard for capital going back to the failures of Webvan and Peapod in the beginning of the last decade.

It’s probably an exaggeration to call Walmart’s efforts a turnaround. But it’s easy to forget that Walmart’s sales stagnated in the first half of this decade and so did the WMT stock price. The stock was dead money for about four years between 2013 and 2017. It’s now risen 40% in the last two years, thanks to an accelerating top line and increasing confidence in its ability to grow its earnings going forward.

The Story Sounds Familiar

What’s interesting about Walmart stock at the moment is that its journey sounds similar to that of other U.S. large-cap consumer companies. McDonald’s (NYSE:MCD) traded sideways from about 2012 through the end of 2015.

Its future seemed at risk amidst the growth of “fast casual” competition and a focus on healthy eating. But CEO Steve Easterbrook, hired in early 2015, rolled out “all day breakfast”, refranchised owned restaurants, and MCD stock doubled.

Last year, Procter & Gamble (NYSE:PG) stock was unchanged versus early 2013. The external pressures on it seemed intense, as private-label products sold at the likes of Walmart and Kroger were hurting PG’s results. Neither an aggressive cost-cutting plan nor a move to sell off smaller brands had worked. But P&G finally managed to accelerate its revenue growth to 5%, excluding acquisitions, in fiscal 2019. PG stock, too has soared. It gained a whopping 75% from its 2018 lows before its recent pullback.

What we’ve seen is that if a U.S. large-cap company can convince the market that it is well-positioned, its stock is going to climb. And it’s likely to move farther, and often faster, than fundamental analysis might suggest.

The WMT Stock Price Is Partially Built on Trust

If that trend holds for Walmart stock, it can rise well above its current level. But that’s a big “if” for two reasons.

First, in terms of the other large-cap stocks, the obvious worry is that their valuations have gone too far. Like WMT stock, PG, for example, trades at 24 times its earnings, and it’s modestly growing. The valuation of many “safe” stocks, including WMT stock, look potentially stretched.

Second, Walmart’s strategy has to pay off. The long-running worry about WMT stock  has been that its e-commerce and omnichannel growth will be good for sales – but won’t necessarily boost its profits.

The ability of Target (NYSE:TGT) to deliver bottom-line growth after spending billions on its omnichannel business likely eases that fear. Still, an investor buying WMT stock at $120 has to believe that its e-commerce growth will add to its earnings and not just its top line.

The Case for Walmart Stock

That said, an investor reasonably could see both risks as overdone. As far as valuation goes, it’s clear that long-term interest rate expectations have come down. If Walmart can grow its earnings even 6% per year, while the ten-year U.S. government bonds yield less than 2%, investors are going to pay for that growth. 24 times EPS for a company that’s growing at 8% sounds high to those of us who have invested for decades. But it may no longer be high.

As far as the concerns about its omnichannel business go, the rebuttal is simple: it’s working. Walmart is a legitimate rival to Amazon. The latter company is valued at almost $900 billion, and perhaps close to $500 billion excluding its Amazon Web Services business. In that context, is the $337 billion market capitalization of Walmart stock too high? An investor could quite easily argue that it’s too low.

Still, an investor needs to have a lot of trust in WMT stock to buy its at its highs. She needs to trust the company’s strategy and the market. If that trust is justified, there’s a path for WMT to follow MCD, PG, and other stocks higher.

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