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