Walmart Crushed: What’s really going on

Remember that time you lost $11 billion dollars?

Probably not, but that’s what happened to the heirs of Sam Walton, the entrepreneur and founder of mega-retailer Walmart. After a sub-par earnings reveal, investors punished the company by taking off $18 billion in Walmart’s market value.

It’s been bad news bears all year as Walmart’s stock price crashed from an all-time high of $90 in January to less than $60 today, the lowest it’s been for three years. If you take this time period into account, the Walton family has lost about $40 million in net worth. They’re still worth over $120 billion, and have more money than the poorest 40% of all Americans, though, so don’t feel too bad for them.

The first true Walmart opened its doors in the early 60s and today the corporation brings in half a TRILLION dollars in revenues across 11,000 stores – operating in 28 countries.

Walmart is the largest company in the world by revenue – and the biggest private employer to boot. The Walmart staff numbers 2.2 million. In comparison, the U.S. only has an active military force of 1.4 million. We’d probably still put our money on the U.S. army though.

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When a corporation reaches that sort of size, it becomes hard to grow. The enormous retailer announced that earnings would be expected to decrease 6-12 percent by the end of January 2017, and because Wall Street analysts were expecting a net gain – things went crazy as the market struggled to adjust to the new information.

Walmart has been trying to reinvigorate the business. They have been funneling cash into its employees and e-commerce segments of the business (which will continue through to 2017 and thus are a net drag on earnings). Walmart raised its base salary in April (to $9/hr) and has plans to elevate that base rate to $10 an hour next year. All told, Walmart will be spending $1-1.5 billion. (2% of total revenues).

Finally, the corporation also green-lit $20 billion in stock buybacks over the next two years – which only adds further costs and doesn’t help Wall Street settle down. From the company’s standpoints, these are all necessary investments.

Stock buybacks are a tricky beast. Generally, companies do this because they either a) want to artificially inflate the price of their stock, or b) because the market has discounted company shares too much.

Buying back shares allow a company to dress up their financials, which in turn acts as a signal to the market that the company is doing better (even if it’s just voodoo). This prompts the public to put money back into the company and in turn boosts the share price. If a company buys their own shares, it means that there are less shares available on the market; i.e. shares outstanding decrease.

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If shares outstanding decrease, that means that return on assets will increase, simply because of the way the metric is constructed.

Return on assets = Earnings / Assets

If you use some of the money in your assets to buy shares, then assets decrease, and (assuming earnings at minimum are unchanged) your ROA will rise.

The same is true of Earnings per Share, another key metric that analysts and investors can get obsessed over.

Earnings per Share = Earnings / Shares Outstanding

This one’s even more straightforward. Buying shares takes them off the market and reduces shares outstanding. If earnings are unchanged, earnings per share rises.

And this trick even works for the P/E ratio (price-to-earnings). The P/E ratio is very well known and as a general rule: the lower the P/E ratio, the better the company is.

Does that make sense? If you have a low P/E, it’s pretty much another way of saying you earn a lot of money (earnings) compared to the price of your shares (price).

And because we saw how Earnings per Share will increase due to a stock buyback, it means that the P/E ratio (as the Earnings per Share increase) will decrease. Remember, lower is better, as it signals to the market that the company is relatively cheap compared to the massive amounts of money it earns.

A stock buyback is not always about financial wizardry though.

Sometimes a company will buy back their shares because the market has, in their view, mis-stepped. As an investor, the company sees that the market has taken their share price down to a very deep discount and will use that opportunity to buy shares that they can always make available again in the future. If you buy at $10 and sell at $20…well, that’s good business.

It’s hard to say what exactly is happening. Walmart didn’t just become a bad business overnight…but the stock buyback announcement did come after the stock plunge. We’ll let you come to your own conclusions on that one.

So, what’s really happening?

There’s one theory. The stock plunge is more a reflection of the overall market sentiment than Walmart’s viability as a company. Until recently, the stock market had gotten used to the Fed doing their quantitative easing and propping up the stock market. In other words, artificially supporting it. Now everyone has to get used to a world where the Fed has stopped Q.E. and is refusing to raise interest rates (a signal to the market that they are NOT confident in the overall economy).

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Put yourself in those shoes. You’re an investor and the country’s central bank hasn’t the confidence in the economy to even raise rates by 0.25% after leaving it at 0% for 81 straight months. What does that tell you?

Industrial production is trending downward in 2015 and shipping volumes are lower year-over-year every month since February. These are not good signs. Fewer and fewer products are being made and as a result, less are being shipped around the country. This is not the mark of a booming economy.

As investors adjust to the new reality, they may overreact to negative news. That’s just the way things work sometimes.

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