Shares of Wal-Mart Stores, Inc. (NYSE: WMT) are appropriate for many investors who are seeking principal protection and current income from dividends. They also may be suitable for value investors, or investors who favor stocks with low share prices relative to the company's earnings and book value. Historically, WMT has been seen as a value investment, however, its fundamentals may be changing making it less attractive to conservative value investors.
Determining a stock's suitability for your financial goals requires analyzing specific ratios from the company's financial statements and comparing those financial ratios to benchmarks and to other companies in the industry. Financial ratios shed light on a company's direction, its probability of remaining solvent and whether its stock is overvalued, undervalued or valued just right.
The price-earnings (P/E) ratio is the primary financial ratio that fundamental analysts use to value a company's stock. The ratio compares the share price to earnings per share (EPS). The average P/E ratio varies by industry, but across the board, it is around 15.
As of Q3 2018, Wal-Mart's P/E ratio is about 20x, meaning that WMT shares trade in the market at around 20 times the earnings per share. The P/E ratio for WMT shares has been rising, and prior to 2017, the P/E ratio for Wal-Mart shares tended to hover just below 14x or 15x. Still, this price-to-earnings is less than half of rival Costco's P/E ratio of 35x. However, the company's other big competitor, Target, has a P/E ratio of just around 16x. This suggests that Wal-Mart is a viable play for value investors but has experienced some price action relative to its earnings lately that may make some value investors uncomfortable. At the very least, the stock does not appear to be grossly overvalued based on earnings.
The price-to-book (P/B) ratio compares the company's market value, which dictates what shareholders pay to own the company, to its book value, which dictates what the company is really worth from an accounting perspective.
Value investors like to see a P/B ratio below 3.0. A P/B ratio below 1.0 suggests an extreme bargain stock. As of Q3 2018, Wal-Mart's P/B ratio was 3.8 (higher than the value investor limit), compared to 4.1 for Target and 8.2 for Costco. Again, Wal-Mart shows characteristics of a reasonably good value buy relative to its competitors.
Return on Equity
Return on equity (ROE) expresses net income as a percentage of shareholders' equity. A company's ROE is a great indicator of how efficiently its management team is performing. Savvy investors want to see that management is able to parlay the company's equity into strong earnings. Hence, a higher ROE is usually a better ROE.
ROE values above 10% are considered strong; an ROE above 25% is considered to be excellent. As of Q3 2018, Wal-Mart's ROE stands at a healthy 18.2%. But, its competitors also turned in strong ROE numbers: Both Costco and Target's ROE comes in around 25%.
Even a mature, profitable company sits in a tenuous financial position if it cannot manage its debt. Recessions and market downturns expose companies that have been too reckless with their debt management. The debt/equity (D/E) ratio expresses a company's total debt as a percentage of its equity. Ideally, a company's debt should be lower than its equity, which means a D/E ratio of under 100% is preferable.
As of Q3 2018, Wal-Mart's D/E ratio is 70%, indicating a healthy level of debt. By comparison, Target's D/E ratio of 109% indicates its debt load has overtaken the value of its equity. Costco's D/E ratio stands at an impressive 52%.
A company's current ratio measures its ability to pay its current debts, defined as those due within one year, and is a measure of a company's short-term liquidity. It does so by comparing the company's current liabilities with its current assets, meaning those that can be converted to cash within a year or less.
The formula is current assets divided by current liabilities. A value of 1.0 or higher is preferred. Many value investors consider 1.5 to be an ideal current ratio. Wal-Mart's current ratio comes in a little low at 0.93. Target's is 0.82, and Costco's is 1.02.
All three companies have current ratios around 1, and the difference between them is insignificant. While a slightly higher current ratio would be good to see from Wal-Mart, its other financial ratios offer confidence that paying debts should pose no problem to the company.
The Bottom Line
Although Wal-Mart has traditionally been viewed as a stalwart of value investing. A blue chip company that dominated the retail space, its fundamentals, based on ratio analysis, indicate that its trend since 2017 has been away from the key metrics sought by a value investor. In fact, Wal-Mart has transgressed several of these thresholds in terms of its debt load, share price relative to earnings and liquidity status. This may be due in part to increased competition from online retailers like Amazon, as well as mounting pressure from brick & mortar stores like Target and Costco.