What Wal-Mart’s $21 Billion Wipeout Really Tells You

Keith Fitz-Gerald Oct 16, 2015
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No doubt you’ve heard about Wal-Mart’s $21 billion wipeout this past Wednesday following revelations from senior management that the company may suffer a 6% – 12% drop in earnings in 2017.

The headlines were certainly hard to miss:

…Wal-Mart Surprises Market With Dim Outlook – The Wall Street Journal

…Wal-Mart Stock Hammered as Profit Warning Triggers Price War Fears – NBC.com

…Wal-Mart Shares Tank on Lower Earnings Forecast – USA Today

…Wal-Mart may need a decade to get its ‘mojo’ back – MarketWatch

Investors may as well be listening to an old Charlie Brown cartoon…wha wha wha.

The actual story here and the one you need to focus on has nothing to do with the company itself but everything to do with a fundamental change in market conditions.

My job is to make sure you and your money come out on the right side of the equation. That way you’re not going to get caught by surprise like millions of investors who will not connect the dots I’m about to share with you.

So let’s get cracking!

Here’s what traders are telling you about today’s markets.

Wal-Mart’s Double-Digit Dive Reflects a New Market Era

Conventional wisdom would have you believe that Wal-Mart is a unique situation and that the lowered expectations are about everything from compressed margins to the fact that Amazon is eating Wal-Mart’s lunch. And, for once, it’s correct. Those things are all true.

But I wouldn’t go so far as to call Wal-Mart a buying opportunity like many analysts including Morningstar’s Ken Perkins, who noted that the selloff is an “overreaction and a buying opportunity.”

That’s because the real story isn’t about Wal-Mart but about a much broader change in market tenor that dramatically increases risks for the unsuspecting and the complacent.

Let me explain.

There’s been a meme since the Financial Crisis began – what’s bad is good and what’s good is bad. Chances are you’ve seen me talk about this many times during major network appearances on Fox, CNBC, and other networks. We’ve also discussed it quite a bit here.

If not, the expression is an ode implying that any bit of bad news is actually good. The thinking is that bad data means further Fed involvement in the markets and lower interest rates.

That’s why the markets have moved higher since 2009 on bad jobs data, terrible consumer confidence figures, and falling earnings. That’s also why the markets have tanked on even the smallest bits of good news, a signal that traders believed would hasten the Fed’s exit.

But now that the Fed has taken a “damn the torpedoes” approach to raising rates, the markets have begun to recognize that bad news is actually bad news – not the good news it was as recently as a few months ago. So they’ve rolled over.

And that, in turn, brings the focus squarely back to earnings, or in this case, earnings potential at a time when earnings are being revised lower faster than Tom Brady allegedly deflated his footballs.

This season, for example, the S&P 500 is expected to report an average year-over year earnings decline of -5.5% for Q3 according to FactSet.

That’s what makes this so dangerous. It’s not just Wal-Mart. There is a much broader swath of corporate America at risk here. Wal-Mart just happens to be the one with the guts to speak clearly about the challenges it’s facing.

Here’s the thing.

When S&P 500 companies report earnings that are above earnings estimates, the overall growth rate goes up because actual earnings numbers replaced lower estimated numbers over time. That, in turn, attracts more capital.

But the converse is true, too. Talking negatively about earnings will in advance makes the effect even more pronounced. So when reported declines hit, they negatively impact actual growth rates which, as you can see below, are already decelerating sharply.

earnings-chart

As an aside, I honestly don’t know why this was such a surprise to Wall Street. We’ve been talking about this since last December and preparing accordingly. But that’s a story for another time.

What you need to keep top of mind is something everybody else seems to be forgetting.

Earnings – above all else – are the single strongest predictor of stock prices over time. If there’s a decline in the works as would appear to be the case, it will be the first back to back series of earnings declines since 2009.

The fact that Wal-Mart is talking about 2017 implies another 4-6 quarters of negative growth ahead. That’s significant because only two quarters of falling GDP are required for a recession.

That’s really what unhinged traders.

Profit growth has never been this weak except in a recession. And that, in turn, means any company – not just Wal-Mart – that misses earnings or lowers expectations is at risk of a similar shellacking in the weeks ahead.

The other thing to keep in mind is that investors who have historically paid up for value over the past 50 years have been paying up for growth in recent years. The fact that they clobbered a long-venerated name like Wal-Mart based on nothing more than expectations more than a year in advance suggests a rising level of desperation, not stability.

So, once again, traders and millions of unsuspecting investors are chasing the illusion of prosperity.

Case in point, Amazon’s fiscal 2016 earnings are expected to grow by 211% on growth of nearly 20% according to S&P Capital IQ. Wal-Mart’s are going to fall by 6%-12% at a time when revenue has flattened. That means Amazon is more “valuable” than Wal-Mart even though the former has only 1/4 the revenue. The irony, of course, is striking; Amazon is perennially unprofitable or just barely profitable.

It makes me wonder if Wal-Mart is going to be more like Twitter than Target, at least in terms of its stock price anyway. Or, for that matter, like Zoe’s, Shake Shack, CenturyLink, BlackBerry or any of dozens of companies we’ve identified at risk of flameout.

Retail-Titans-chart-walmart

You may think that’s a stretch and I respect your opinion. Sam Walton is a business icon and Wal-Mart is as American as apple pie, baseball, and big discounts. It’s very hard to comprehend a company like Wal-Mart going into the dumper.

But then again, people thought the same thing about once great chains that are now a fraction of what they used to be including: Sears, JC Penny, Macys, Montgomery Ward and Kmart, for example.

Companies that base their profits on unsustainable price and cost strategies will eventually pay a terrible price. Put bluntly, you can’t over-earn for long because eventually expectations catch up with reality.

There are a few key takeaways here.

  1. More than 100 million Americans shop at Wal-Mart weekly, so the dramatic drop in earnings projections tells me that the middle class is in more trouble than previously acknowledged and that the recovery Washington thinks is moving along is actually shifting into reverse.
  2. People have almost completely overlooked the fact that Wal-Mart’s CFO, Charles Holley, specifically called out the $1.5 billion being spent on increased wages and training as a causal factor in his remarks. That’s proof positive that the increased wages everybody’s been screaming about in politically charged circles do have a very real effect on bottom line earnings. Further, that it’s not good. I pointed this out to you in last June while describing the most pressing reason yet to avoid retail stocks.
  3. Traders are calling the Fed’s bluff while at the same time meting out severe punishment for any company that dares to go against the officially accepted party line and declare the “Emperor has no clothes” as Wal-Mart has effectively done here. This signals a shift to more speculative trading and even higher volatility ahead as traders are forced to chase increasingly risky returns. The “must-haves” we talk about repeatedly are going to be your security blanket because of the inherent stability they offer.
  4. Any business that fails to acknowledge the disruptive power of competing technologies, specifically as they relate to e-commerce, will lose its cost advantage and may never recover. Instead of dominating the industries they created, they will turn into followers and, if they’re lucky, survivors. Many will go out of business or suffer a Blackberry-like fate as customers “pull” from their favorite retailers rather than accept what’s “pushed” upon them by traditional retailers.

Wal-Mart proponents will no doubt offer plenty of resistance.

The “hit” will be worth it, they’ll say. The investments in people and technology will pay off eventually, they counter.

Perhaps.

If you’re tempted to buy, ask yourself if you have a decade or more to wait for that to happen.

That’s how long it’s taken Kroger and CostCo to recover from similar resets.

Until next time,

Keith

38 Responses to What Wal-Mart’s $21 Billion Wipeout Really Tells You

  1. ron says:

    WMT in the $50’s seems like a good buy. It’s a money making company with a 3% dividend. If the US is heading for a recession, as some analysts are saying, WMT is the stock to own.

    • Keith says:

      Morning Ron.

      Under normal circumstances, I would agree with you but against the backdrop of higher costs and lower profitability, I think the game has changed. Wal Mart is still a fine stock, but the opportunity cost may be too high given alternatives.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  2. dbtheonly says:

    Keith,

    I’m not sure that a pay scale that doesn’t allow its employees to get off Public Assistance is really a sustainable model. If the company itself is “on welfare” because we, through welfare are subsidizing it’s low wages, should we be surprised that its valuations are artificially high? Or surprised that these valuations fall?

    At its current ~$58 price, WMT is throwing off ~3% per year in dividends and is a little over 12 PE.

    Which leads me to another question. As WMT, and others, AAPL etc., become larger the dollars needed to maintain a certain percentage of growth become larger. Above a certain size, does growth become a flawed metric?

    • Keith says:

      Dear DB,

      You’ve certainly hit the nail on the head. But that’s the dilemma. Wal Mart employs 1.4 million Americans, all of whom deserve higher wages. Yet, 100 million people shop there a week. The question – and the battle that’s being played out – is whether you give higher wages to 1.4 million workers or force 100 million people to deal with higher prices on everything.

      Further, your point on the potential of a flawed metric is a good one that I hadn’t considered before. I’ll take a look and let you know what I find.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  3. Tom Lamont says:

    Congrats Keith. This is the most telling editorial I have yet read on what is happening in retail. The rules are a changing and investors need to pay attention to your thesis. Bricks and mortar are proving to be a liability. I was amazed this week to order an item on line from a Canadian retailer, and find out the order was shipped with no shipping charges from a US based outfit. Yes times are a changing!

    • Keith says:

      Hello Tom,

      Thanks for the kind words! I am continually amazed by the intersection – some would say collision – of bricks and bites.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  4. lewis smith says:

    what is going on with amba ambarella inc.

  5. SIVAJI SIRIMALLE says:

    Keith,

    Great article with lot of useful info. My One question is, if the deflation is coming here big time, wouldn’t that going to help the companies like Wal-mart and dollar mart and dollar general ?? Overall they might loose to e-commerce businesses some piece of the pie. I wanted to your view point on if the deflation gets the grip on global economy, people depend on low cost products, there by the trend will help wal-mart and dollar generals etc.. Just a thought.

    Thanks,
    Sivaji Sirimalle

    • Keith says:

      Dear Sivaji,

      Thanks for taking the time to write. I think that’s a great question.

      I’ve actually had first hand experience with this in Japan in the 1990s when deflation began to set in there as part of the Lost Decade. Retailers with flexible purchasing chains did very well but the bigger retailers with purchasing contracts actually suffered initially because they bought in bulk using fixed prices a la Wal Mart. Eventually, the scale paid off as contracts came up for renewal but it made for tight profits initially.

      I see the same thing here. Our leaders seem determined to foster business conditions that are a direct repeat of what Japan’s still living through 25 years later.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  6. Bob Weir says:

    It just might be that Wal-Mart, in the future, is associated with appealing to “older” shoppers, whereas Amazon attracts “younger” shoppers. If so, for Wal-Mart, that could be good (the burgeoning older demographic), or it could be bad (it is the younger crowd that increasingly will be spending their wages, via the internet and not in considerably less-crowded stores). Can the future Wal-Mart adapt to the younger style of shopping? I doubt it!

    • Keith says:

      That’s a very interesting point, Bob.

      The age-related wrinkle is one that I don’t see a lot of retailers latching on to yet. But, I suspect to your point, that they will be forced to.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  7. Eward Owen says:

    Good Morning- I am in a transition period, divorce in august and just finished refinance this month. that said I’m trying to put together enough money in my Ameritrade account to be worthwhile in the trades you are bringing to light. Right now I have 1250.00 there and it seems a 10000.00 is where I need to be. I plan to add to the account, but feel I’m missing out on profit.

    • Keith says:

      Dear Eward,

      Thanks for sharing. It sounds like you’ve got a lot going on and that’s a good thing because transitions often prove to be the start of an entirely new phase in life. No doubt they can be difficult for any number of reasons, but they’re still almost always the start of something new.

      Speaking of which, I think you’re on the right track. Saving money and putting it to work are the single biggest challenges. Begin small with the intention of locking up “core” assets like the Vanguard Wellington that will be the foundation around which you build other investments. Then branch out as I advocate in the Money Map Report using something like the 50-40-10 model. Not only will that help build up returns, but manage risk, too.

      And finally, don’t worry too much about the feeling of missing out on profit. That’s normal and it proves that you’re paying attention to the world around you. The markets will always be there and now that you’re putting money aside, you’re going to be poised to capture the many opportunities out there.

      I’ll do my best to help.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  8. Jim says:

    Keith, how do I get more info on your subscription service? Your articles today have truly resonated with me. I’m tired of all of the “talking heads”. I’ve lost loads with bad advice! I could use some real help. Thanks in advance!

    • Keith says:

      Thanks for the kind words, Jim.

      I try my very best and am honored by your trust. My suggestion is to check out the Money Map Report. Keep reading Total Wealth obviously, but consider starting there. It’s build around a safety-first model that follows the very same 6 Unstoppable Trends we track here.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  9. Cathy Michalak says:

    I was ripped off by Amazon in a big way attempting to work for them over the computer ($4,000+). I later found out that a friend of mine was as well. ($15,000.). So I do question their tactics…
    I’m amazed at the trend taking place and I try to maintain a few investments. Thank you ~

    • Keith says:

      Good morning Cathy.

      Yikes! I’d be interested in hearing more about your Amazon experience some time. I suspect there’s an interesting article in there and that you’re not alone. And, way to go for staying in the markets. Amazon or not, there’s still a lot of opportunity out there!

      Best regards and thanks for being a part of the Total Wealth Family, Keith 🙂

  10. Steve says:

    Thank you. Well reasoned remarks. “Too big to fail”, is something that might be in people’s memories. Wal Mart has seen favor, and now meets fate…..could be the expression we share.

    • Keith says:

      Hello Steve.

      If you don’t mind, I’m going to borrow that expression…has seen favor now meets fate. That sums things up nicely.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  11. roger says:

    Excellent article, really helped me understand the bigger picture.

  12. Steven says:

    Thought your article interesting and informative and could not find anything I could disagree with.

    • Keith says:

      Good morning Steven.

      Thanks for the kind words. They are much appreciated. And, by the way, please disagree with anything I write. That’s how we all learn – through dialogue and discussion. I only wish our leaders still understood that.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  13. robert lucy says:

    What do you recommend I do with the Wal-Mart stock I have.

    Thanks,
    Bob

    • Keith says:

      Good morning Bob.

      Unfortunately, I don’t know your personal situation so it would be terribly inappropriate (not to mention illegal) for me to render personalized advice. That said, I would encourage any investor in your position to ask themselves how Wal Mart fits with the rest of the portfolio and to revisit the reasons you own it. If those still fit – income, stability, time frame, etc – then keeping it may not be the worst option, albeit with careful risk control. If you believe like I do that there are other alternatives, then selling or lightening up may be the best course.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  14. Houyhnhnm says:

    There are many potential bright spots in Wal-Mart’s problems besides Amazon stock. If millions of low-wage workers are really going to start catching up with inflation after years of falling behind (I want to see confirmation that really happens) they will be buying stuff. I don’t shop at Wal-Mart, but I notice a lot of low-wage workers with stylish jeans and nice-looking phones in their hip pockets. What phones might they upgrade to (can they afford Apple products)? And what carriers do they use? And if I were a real gambler I’d want to know what brands of clothes they buy.

    Houyhnhnm

    • Keith says:

      Hello Houyhnhnm,

      I think that’s a great observation. My question is who’s paying for all that bling. I think the stop gap is going to show up in credit card defaults. Ultimately the risk shifts somewhere and will show up.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  15. John R Stockhausen says:

    RE: Keith Fitz Gerald, Thank you so much for all the info you’ve sent me. It’s really appreciated more than you know.
    Per to the markets at this time, do you think it is a smarter thing to stay out of individual stocks rather than wait for the markets like Europe, China or the U.S. to use (Inverse ETFs) or even (The euro vs the dollar) & when gold & silver bottoms, use a (Leveraged ETF) on metals only???? Keith, what are your thoughts about this info I’m sending you???
    When you get a chance, could you please send me this info???? This really would be appreciated more than you know.
    Sincerely Yours, John R Stockhausen

    • Keith says:

      Good morning Mr. Stockhausen.

      Thanks for the kind words! They are appreciated very much as are your questions.

      I think the answer comes down to individual preference. The problem with funds is that they tend to sweep in both the cash and the trash. Individual securities, on the other hand, allow you to focus very specifically. Leveraged stuff, though, is another matter. Barring very short time frames, they’re generally a bad idea for most investors because of tracking error.

      All the best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  16. ronnie says:

    THANK YOU FOR THIS REPORT. I HAVE SAID FOR YEARS EVERYONE THINKS WAL-MART WOULD NEVER FALL BUT I ALWAYS TOLD THEM LOOK AT SEARS, MONTGOMERY WARDS, ECT. NOTHING IS BEYOND FALLING. PEOLE IN THE DAY NEVER THOUGHT THEY WOULD SEE SEARS FALL BUT LIKE ALL BIG CO. THEY HAVE THEIR TIME, AND DAY. THANK YOU AND KEEP UP THE GOOD WORK.

    • Keith says:

      Good morning Ronnie.

      Well put. History’s graveyard is filled with companies people thought incapable of failing – Eastern Airlines, the retailers you mentioned, Pan Am, Blockbuster, Commodore Computer, etc.

      Never forget the words of General George Armstrong Custer in 1876, “there are not enough Indians in the world to defeat the 7th Cavalry.”

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  17. H. Craig Bradley says:

    LETS GO TO THE MOVIES FOR MARKET ANALYSIS

    Lets take a favorite line from a Classic Movie, ” The Treasure of Sierra Madre”: ” Profits (‘Badges”), profits, we don’t need no stinking profits”. Seems to sum-up this “unloved” bull market.

    Although investors are often all-in due to greed or peer pressure, many at the same time also lack strong conviction. So, emotions of market players are often conflicted. Thus, it really only takes very little truth ( once widely recognized) to jolt many investors to go quickly into Sell mode or Panic mode ( ” Flash Crashes”) .

    Each time, this baffle’s the financial press. Its during these brief but recurring episodes of revelation (truth) that we can see more clearly how bad (or weak) the economy actually is, as well as the markets built upon the FED’s edifice ( Actually, ” House of Cards” of sorts).

    When real risk is staring at you in the Face, markets and investors run ( stampede). Enhanced herd behavior is my biggest concern with this so-called “Facebook Market”. Its not real, or is it? We will eventually find out, like the late Charlton Heston when he rode his horse along the beach in the Classic Movie ” Planet of the Apes”. Taylor did not “like” what he found.

    • Keith says:

      Good morning Craig.

      Well put, as always.

      That scene in Planet of the Apes is one of my favorites by the way because it’s a reminder that hubris ultimately catches up with even the unsuspecting.

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  18. John Chaves says:

    This was a great analysis except that Tom Brady did not deflate any footballs and was exonerated when Judge Berman sided with the Players Association,

    • Keith says:

      Hello John.

      Thanks for the kind words…as for Tom, “allegedly deflated” We’ll enjoy a libation together sometime and debate the finer points of football air pressure!

      Best regards and thanks for being part of the Total Wealth Family, Keith 🙂

  19. Dick says:

    Great article Keith,

    I have been trying to understand what is actually going to happen at the International Monetary Fund meeting on September 2016. I’ve been reading that China will be allowed into the IMF at that meeting ?
    There is some speculation a new world currency is on the horizon. It has been cased as funny money for lack of a better word that will be used by all? China has been buying up gold by the metric ton’s as well as gold mines for several years I have read and there are other countries hoarding gold as well I’m not sure why unless they are going to issue a currency backed by gold, In any event,
    Some individuals are beginning to get the impression that whatever the IMF is proposing may cost the United States dollar to lose it’s title of the world’s foremost reserve currency status.
    I’m not so savvy about such stuff and thought you may shed some light on it ?
    Thank you for all the fine work you do.

    Kindest personal regards

    Dick Upton

  20. Sandra Gustafson says:

    Who thinks this scenario COULD happen, BEGINNING in September of 2016 (IMF MEETING), besides me?
    China voted in=======> United States loses its status as the World’s foremost reserve currency.
    China announces its “Yuan” is backed by Gold (one of the dumbest things our government ever did away with).
    United States Debts ==============> Head into default (who will want to loan us money now?)
    United States Government freezes all access to your cash, IRA’s, 401k’s, and Safety Deposit Boxes (signed into law recently, giving our government the right to do this).
    United States Government takes funds from the above to pay off the US Debt (no they can’t you say……really?)
    United States Government makes it illegal to own gold again….you have to turn it in for greatly devalued US Currency.
    United States Economy begins to crumble at an alarming rate, bringing on what I would call the “Greater Depression”.
    Stock Market crashes even worse than during the Great Depression; unemployment significantly higher than then too.
    Gold, silver, guns, ammunition and supply of food/water will hold a significant value, along with an ability to bug out to an unknown, extremely hard to find, remote location.
    BOTTOMLINE: I hope I am dead wrong.

  21. Mac Townsend says:

    Keith I found your article about Wal-Mart puzzling . Are you saying that the this Wal-Marts of world can not afford to pay their employees a living wage and stay in business? My question is if people can not make enough to sustain themselves who will be able to buy the goods and services needed to keep the economy going. Oh, and the family that owns Wal-Mart is one of the wealthiest in this country. The company’s you mention in your article did not fade because they had to pay their employees, rather they suffered from poor management and failure to adjust to changing demographics. What are your views on McDonalds and its prospects for the future?

    Sincerely, Mac

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