Fis Malsori

3/20/2016

V ALUING W AL -M ART
C A S E R E P OR T

FIN 7410

Fis Malsori
3/20/2016
0

Fis Malsori

3/20/2016

Introduction
Sabrina Gupta, an investment advisor is examining Wal-Mart Stores Inc. (NYSE: WMT) stock and its
valuation. She wants to use multiple methods to value the stock and come to a conclusion on its value and
the reflection of the share price on the market. Her goal is to confidently recommend her clients to buy,
hold or sell Wal-Mart stock based on her analysis.

Wal-Mart currently operates in multiple markets and sub-markets and compares well to its competitors
both domestically and internationally. However, determining Wal-Marts performance relative to its
competitors is difficult since very few if any of its competitors has the diversification that Wal-Mart has.
A thorough analysis of separate divisions of Wal-Mart and other companies would be needed. Moreover,
with the information given in the case such as: P/E Ratio, Return Ratios, D/E Ratio and other, we can
conclude that overall, Wal-Mart is performing better than the industry average and S&P 500. Relative to
its closest competitor in general merchandise, Target, the company is providing higher return on equity to
shareholders but is less leveraged, yet has a slightly lower net margin and a lower P/E Ratio than Target
and the industry. A thorough comparison of Wal-Mart with its competitors given the information in the
case is not easily done due to the different capital structures of the companies in different sub-sectors.

Given the data in the case, analysts see Wal-Mart growing at 10.40% over the next five year, lower than
Target and the Standard & Poor 500, and significantly lower than the industry projections for the next five
years. Wal-Mart was founded to save people money and offer them convenient shopping under one roof
& this business model is one of the companys major drivers of growth and expansion as it has captured
millions of people worldwide generating 405 billion dollars in revenue just in 2010. One of its major
weaknesses is Wal-Marts diversification itself, as it creates opportunities for competitors to specialize
and capture market share in specific sub-industries.

From 1974, Wal-Mart has enjoyed an earnings growth of an average of 25% annually, yet it has
significantly slowed to a high of 16.4% in 2005 and a low of 6.0 % in 2009 indicating a matured company.

Fis Malsori

3/20/2016

Historical Analysis
Analyzing Wal-Marts Historical growth in earnings, dividends and payout ratios will reveal the trends
that emerge for the company and will show a better picture of the company for investors.

Historical Growth, Payout Ratio & EPS

5
100

4.5
4

80

3.5
3

60

2.5
2

40

1.5
1

20

0.5
0

1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010

Annual Earnings Growth (%)

Annual Dividends Growth (%)

Dividends Payout (%)

Earnings/Share

Dividends/Share

In the table above, generated from the data given in the case we can see that both Earnings per Share as
well as Dividends per share have grown significantly in the last 30 years. Annual Earnings growth
however, has recently stalled and as explained earlier, will indicate a more matured company to investors.
Dividend growth has also significantly declined in the long-term, yet in the last decade, it has had some
growth in 2005 and 2008. Wal-Marts Dividend Payout Ratio has increased overtime, roughly twice the
amount from the beginning of this millennium to a 29.3% payout ratio in 2010, also indicating that WalMart is not growing rapidly anymore. The most recent payout ratio is still significantly lower than an
industry average of 45%, which still leaves much room for investors to question about potential growth
opportunities of the company to invest in attractive projects by retaining and reinvesting cash as opposed
to paying out more to shareholders.

Fis Malsori

3/20/2016

Perpetual Dividend Growth Model

Initially, a Perpetual Dividend Growth Model will be used accompanied with a three scenario sensitivity
analysis to value Wal-Marts shares and give a recommendation to investors.
Major Assumptions for the Perpetual Growth DDM:

Consensus Dividend of D1= $1.21

Perpetual Dividend Growth Rate of g=5.0%

Cost of Equity Capital re= 7.1%

With the above mentioned method, the following results are computed:
P0 =

P0 =

D1
rE g

1.21
0.071 0.05

Using this perpetuity dividend growth model, share price of $57.62 is valued, which when compared to
Wal-Marts recent close price of $53.48 indicates an undervalued stock price and therefore would yield
a Buy and/or Hold recommendation to Ms. Guptas clients, depending on their portfolios and
whether they already hold WMT shares.
If the assumptions above about growth and cost of equity capital where to be altered and a three scenario
analysis would be conducted, the following would emerge:
Sensitivity Scenarios*
Worst
Assumptions

Re=10.1%

Stock Value
Recommendation

g=3.0%

Current
Re=7.1%

g=5.0%

Best
Re=7.1%

g=6.0%

$17.04

$57.62

$110.00

Sell

Buy/Hold

Buy

*A detailed Scenario Analysis to show a thorough sensitivity of the perpetual model is provided in the
appendix (Exhibit 1.1).

Fis Malsori

3/20/2016

Multi-Stage Dividend Discount Model

Due to the simplicity of the perpetual growth model, it is very unlikely that it captures the growth and
expansion potential of the company correctly, and thus reflecting the value of the stock accurately.
Therefore I will use a three-stage valuation model to analyze and value Wal-Marts share price.
Major Assumptions:

Cost of Equity Capital re= 7.1%

Growth Period
o Years - 5yrs
o Starting EPS $3.72 * Growth Rate (1+10.40%) = $4.11
o Growth Rate 10.40%
o Payout Ratio 29.3 %

Transition Period
o Years 12yrs
o Growth Rate Incremental Declining factor approx. 0.5%
o Payout Ratio Incremental Increasing Factor approx. 1.20%

Maturity Period
o Payout Ratio 45%
o Retention Rate 55%
o Growth Rate ( Retention Rate*Cost of Equity Capital) 3.91%

Using a three stage dividend discount model, Wal-Marts stock should be valued at $90.05 (See Exhibit
2.1), which indicates that the shares are undervalued and therefore, would also yield a Buy and/or
Hold recommendation, relative to Ms. Guptas clients portfolio structure.
In order to meet analyst consensus price of $60.5, a perpetual growth rate of 1.9843% has to be assumed,
keeping retention rate at maturity & cost of equity capital unchanged.

Fis Malsori

3/20/2016

The following table will show a scenario analysis of the three stage dividend discount model given some
major assumption changes in growth of Earnings in the growing period as well as at maturity:
Initial Growth of EPS

Long-Term Growth

IG-2%

Initial Assumption

IG+2%

8.4%

10.4%

12.4%

G-1%

2.91%

$59.48

$71.30

$85.40

Initial Assumption (G)

3.91%

$74.81

$90.05

$108.28

G+1%

4.91%

$104.06

$125.84

$151.94

From the scenario analysis above, we can conclude that almost in every considered scenario, we meet
and exceed analyst consensus price target of $60.5 indicating that even if Wal-Mart doesnt meet
analysts expectation on earning growth in the next five years, nor long term growth expectation given
the expected payout ratio at maturity, it will still render current share price valuation higher than recent
close price of $53.48 meaning its undervalued in every above considered scenario.

Market Multiple Valuation P/E Ratio Method

I will use a P/E Ratio Method because there is readily available data given in the case for this method.
Conversely, if for instance the EV/EBIT Multiple would be considered, there is room for mistake when
assuming excess cash and potentially market value of net debt. I will use both a Wal-Marts projected
P/E Multiple as well as an industry average projected P/E Ratio Multiple.
First, lets look at Wal-Marts P/E Multiple approach using their projected EPS of $4.11 for next year:
Pwmt = P/E Ratio EPS
Pwmt = 13.4 $4.11
Pwmt = $.

Conversely, the forward looking approach using industry average projected P/E and Wal-Marts next
years expected EPS will generate the following:
Pindustry = P/E Ratio EPS
Pindustry = 14.23 $4.11
Pindustry = $.

Fis Malsori

3/20/2016

The valuation of Wal-Mart stock using the P/E Ratio renders similar conclusions like the earlier used
methods, yet the major assumption in this valuation method is that Wal-Mart will exceed its P/E Multiple
projections and will eventually meet the industry average P/E ratio of 14.23.
First, the trailing approach yields the stock to be slightly undervalued and would therefore be a
Hold/Buy for clients with WMT stock or a Buy for the ones without the stock in their portfolio.
Similarly, the forward looking approach renders the stock as undervalued and would therefore suggest
a Buy recommendation to WMT holding clients as well as non-holding ones.
However, the P/E Ratio Multiple Valuation method has some underlying considerations about a
companys accounting methods and financing structure. Also, taking the industry average is risky as
companies in the same industry will very unlikely have similar risk factors, payout ratios, or growth
expectations.

Conclusion and Recommendation

First, the use of DDM with the given data in the case seems appropriate as Wal-Mart has consistently paid
out dividends since it became a public company. However, this method requires for dividend projections
which are discretionary to the company and is thus subject to significant error. Furthermore, given
information in the Consolidated Statements of Shareholders Equity in Wal-Marts 10-K report, it
shows that the company uses other methods of returning capital to investors, such as share repurchases.
Therefore, we can confidently conclude that Ms. Guptas approach is not the most appropriate to use since
share repurchases decrease the number of shares outstanding thus increasing EPS and Dividends per share.
To conclude, the valuation done in this report is subject to considerable error and would not be a reliable
way of recommending investment decisions to clients. I recommend using the Free Cash Flow Method to
value the company and its stock price as it allows for easier comparison of companies with different levels
of debt and is not dependent on companys payout ratio.

Fis Malsori

3/20/2016

APPENDIX
Exhibit 1.1 Perpetual Growth Dividend Discount Model Sensitivity Analysis

P
e
r
p
e
t
u
a
l
G
r
o
w
t
h

(
g

-3.00%
-2.00%
-1.00%
0.00%
1.00%
2.00%
3.00%
4.00%
5.0%
6.00%
7.00%
8.00%
9.00%
10.00%
11.00%
12.00%
13.00%
14.00%
15.00%

2.1%
$ 23.73
$ 29.51
$ 39.03
$ 57.62
$ 110.00
$ 1,210.00
$ (134.44)
$ (63.68)
$ (41.72)
$ (31.03)
$ (24.69)
$ (20.51)
$ (17.54)
$ (15.32)
$ (13.60)
$ (12.22)
$ (11.10)
$ (10.17)
$
(9.38)

3.1%
$ 19.84
$ 23.73
$ 29.51
$ 39.03
$ 57.62
$ 110.00
$ 1,210.00
$ (134.44)
$ (63.68)
$ (41.72)
$ (31.03)
$ (24.69)
$ (20.51)
$ (17.54)
$ (15.32)
$ (13.60)
$ (12.22)
$ (11.10)
$ (10.17)

4.1%
$ 17.04
$ 19.84
$ 23.73
$ 29.51
$ 39.03
$ 57.62
$ 110.00
$ 1,210.00
$ (134.44)
$ (63.68)
$ (41.72)
$ (31.03)
$ (24.69)
$ (20.51)
$ (17.54)
$ (15.32)
$ (13.60)
$ (12.22)
$ (11.10)

5.1%
$ 14.94
$ 17.04
$ 19.84
$ 23.73
$ 29.51
$ 39.03
$ 57.62
$ 110.00
$ 1,210.00
$ (134.44)
$ (63.68)
$ (41.72)
$ (31.03)
$ (24.69)
$ (20.51)
$ (17.54)
$ (15.32)
$ (13.60)
$ (12.22)

6.1%
$ 13.30
$ 14.94
$ 17.04
$ 19.84
$ 23.73
$ 29.51
$ 39.03
$ 57.62
$ 110.00
$ 1,210.00
$ (134.44)
$ (63.68)
$ (41.72)
$ (31.03)
$ (24.69)
$ (20.51)
$ (17.54)
$ (15.32)
$ (13.60)

Cost of Equity Capital (Re)

7.1%
8.1%
9.1%
$ 11.98 $ 10.90 $ 10.00
$ 13.30 $ 11.98 $ 10.90
$ 14.94 $ 13.30 $ 11.98
$ 17.04 $ 14.94 $ 13.30
$ 19.84 $ 17.04 $ 14.94
$ 23.73 $ 19.84 $ 17.04
$ 29.51 $ 23.73 $ 19.84
$ 39.03 $ 29.51 $ 23.73
$ 57.62 $ 39.03 $ 29.51
$ 110.00 $ 57.62 $ 39.03
$ 1,210.00 $ 110.00 $ 57.62
$ (134.44) $ 1,210.00 $ 110.00
$ (63.68) $ (134.44) $ 1,210.00
$ (41.72) $ (63.68) $ (134.44)
$ (31.03) $ (41.72) $ (63.68)
$ (24.69) $ (31.03) $ (41.72)
$ (20.51) $ (24.69) $ (31.03)
$ (17.54) $ (20.51) $ (24.69)
$ (15.32) $ (17.54) $ (20.51)

10.1%
$
9.24
$ 10.00
$ 10.90
$ 11.98
$ 13.30
$ 14.94
$ 17.04
$ 19.84
$ 23.73
$ 29.51
$ 39.03
$ 57.62
$ 110.00
$ 1,210.00
$ (134.44)
$ (63.68)
$ (41.72)
$ (31.03)
$ (24.69)

11.1%
$
8.58
$
9.24
$ 10.00
$ 10.90
$ 11.98
$ 13.30
$ 14.94
$ 17.04
$ 19.84
$ 23.73
$ 29.51
$ 39.03
$ 57.62
$ 110.00
$ 1,210.00
$ (134.44)
$ (63.68)
$ (41.72)
$ (31.03)

11.6%
$ 8.29
$ 8.90
$ 9.60
$ 10.43
$ 11.42
$ 12.60
$ 14.07
$ 15.92
$ 18.33
$ 21.61
$ 26.30
$ 33.61
$ 46.54
$ 75.63
$ 201.67
$ (302.50)
$ (86.43)
$ (50.42)
$ (35.59)

12.1%
$
8.01
$
8.58
$
9.24
$ 10.00
$ 10.90
$ 11.98
$ 13.30
$ 14.94
$ 17.04
$ 19.84
$ 23.73
$ 29.51
$ 39.03
$ 57.62
$ 110.00
$ 1,210.00
$ (134.44)
$ (63.68)
$ (41.72)

12.6%
$ 7.76
$ 8.29
$ 8.90
$ 9.60
$ 10.43
$ 11.42
$ 12.60
$ 14.07
$ 15.92
$ 18.33
$ 21.61
$ 26.30
$ 33.61
$ 46.54
$ 75.63
$ 201.67
$ (302.50)
$ (86.43)
$ (50.42)

Exhibit 2.1 Three Stage Dividend Discount Model

Maturity Period (g2)

Payout at Maturity
Retention rate at Maturity
Growth rate at Maturity
Transition Period

Transition years
Other Information

Current Fiscal year EPS

Current Dividend
Maturity Payout (p2)
Growth + Transition Years
Terminal Value (TV) = div1/(r-g)

Gr
ow
th

Growth Years
Initial Growth Rate of EPS

sit
io
n

Growth Period (g1)

7.10% Year Assumtpion EPS EPS Growth Dividend Payout

TV
PV(Div+TV)
1
4.11
10.40%
1.20
29.30%
1.12
2
4.53
10.40%
1.33
29.30%
1.16
5
3
5.01
10.40%
1.47
29.30%
1.19
10.40%
4
5.53
10.40%
1.62
29.30%
1.23
5
6.10
10.40%
1.79
29.30%
1.27
6
6.70
9.90%
2.05
30.51%
1.36
45.00%
7
7.34
9.40%
2.33
31.72%
1.44
55.00%
8
7.99
8.90%
2.63
32.92%
1.52
3.91%
9
8.66
8.40%
2.96
34.13%
1.59
10
9.34
7.90%
3.30
35.34%
1.66
11
10.04
7.40%
3.67
36.55%
1.72
12 12
10.73
6.90%
4.05
37.75%
1.78
13
11.41
6.40%
4.45
38.96%
1.82
14
12.09
5.90%
4.86
40.17%
1.86
$3.72
15
12.74
5.40%
5.27
41.38%
1.88
$1.09
16
13.37
4.90%
5.69
42.58%
1.90
45.00%
17
13.96
4.40%
6.11
43.79% 204.2
65.54
17
18 Maturity
14.50
3.91%
6.53
45.00%
Share Price
$90.05

Tr
an

Cost of Capital ( Re )