This paper is examining Wal-Mart Stores, Inc. and analyzing the value of its stock to make a buy/sell recommendation. The valuation is based on a variety of techniques to price the shares and then compare the intrinsic value with the currently trading market price: Dividend Discount model, CAPM, Three-Stage Approach and the Price/Earnings Multiple Approach. Executive Summary Founded by Sam Walton, Wal-Mart is the largest retailer in the world providing a huge assortment of merchandise, electronics, hardware and groceries at “everyday low prices”. 2010 Wal-Mart’s net sales were more than $405US billion. Wal-Mart had an initial stock price of $16.50/share in 1970. Since then Wal-Mart’s dividend went up to $1.09/share in 2010 after it had undergone 11 two-for-one stock splits. Wal-Mart’s recent closing price was $53.48. According to Bloomberg, Wal-Mart’s stock were ranked as “buys’ by 20 analyst – can we justify this recommendation or does our valuation have a different outcome? Valuation: Utilizing the DDM, the current stock price of Wal-Mart is equal to the PV of all expected future dividends discounted at an investor’s required or expected rate of return:

The case provides a consensus annual Wal-Mart dividend for 2011 of $1.21(D1) and an expected constant dividend growth of ≈5.0% (g). To calculate the current price (Po), we need to come up with (Ke). Since we do not have the investor’s required rate of return we can use the CAPM to calculate an expected rate of return. The current long-term government bond yield or risk-free rate is given to be 3.68%, whereas the historical U.S. market risk premium (MRP) was estimated to be 5.05% and Bloomberg’s beta estimated is 0.66. This means that Wal-Mart’s stock is less risky, which is in line with Wal-Mart being a consistently growing grocery store and retailer. Even if the market would decrease by 1%, the Wal-Mart stock can be expected to decrease by less than 1% - because even in recessions, people will always need groceries. The beta of less than 1 shows that Wal-Mart is less volatile than the market. Beta of 0.66 is also in line with the grocery and food industry. Wal-Mart is providing affordable groceries for everybody. Food is a physiological need and is therefore located on the bottom of Maslow’s hierarchy of needs. People will always have to buy groceries, even in recession they are more likely to cut other luxurious goods or services back if the money is tight. Therefore Wal-Mart’s risk premium can be calculated as the product of beta times the Market Risk: . The expected rate of return (Ke) then is: . So for the current stock price (Po) we then get:

Therefore the DDM and the CAPM are valuing Wal-Mart’s stock higher than the recent closing price of $53.48. According to DDM, the Wal-Mart stock appears to be undervalued assuming the dividend growth, beta and MRP estimates are correct.

The Three-Stage Approach is dividing the future growth of Wal-Mart in three periods. Assumption for this model is that the abnormal growth years and transition years must total 17. This model is based on a lot of assumptions and input variables which are critically for the outcome price. The case and this report are assuming an initially growth in earnings of 23.3% which is in line with the geometric average of the Annual Earnings Growth % (in Exhibit 3), as well as a target cost of capital of 12%. The initial growth of 23.3% seems very high at first, but the case also mentions that there is an abnormal high growth expected in the next five years. Initial EPS is 2010s EPS of $3.72 times the geometric mean of 23.3%, which equals $4.59 (used as initial growth rate of EPS). I am also assuming 2010s payout ratio of 29.3% to be my initial payout ratio for the three stage approach, therefore the payout rate in the transition years only increases by 1.21%. I am assuming a payout rate of 45% at maturity.

Given all the assumptions above, the three stage approach is giving us a theoretical price of $127.87, which is a lot higher than the current closing price. Thus, Wal-Mart is undervalued. This report will include two additional scenarios: 1.) Let’s assume the initial growth rate of EPS is smaller than the geometric average (23.3%) due to economic circumstances such as recession. From 2009 to 2010 the EPS grow 4%. If we assume that it grows 4% from 2010 to 2011 as well, the input for the three stage approach would be 15%, which would change the outcome:

The different assumptions change the theoretical price drastically. According to the three stage approach with these modified assumptions, the theoretical price is $60.65, which is still more than the last closing price – therefore Wal-Mart is undervalued.

2.) If we assume only 3 years of abnormal growth years instead of 5 and 14 transition years the price estimate changes:

After changing the number of growth years, the theoretical price is still higher than the most recent closing price and therefore Wal-Mart is undervalued. The Price/Earnings Multiple Approach is estimating the value of the Wal-Mart stock by deriving from the pricing of an comparable asset, in this case price/earnings information. The case is using Target as WalMart’s closest competitor, although Target is only comparable in the general merchandise area, it is not offering the broad assortment of housewares, electronics and hardware in combination of groceries. Therefore the multiples approach may not be ideal to use for valuing Wal-Mart since there is no other market out there using the same concept as Wal-Mart and thus it may be really subjective and difficult to

find a real comparable firm. Also, estimated EPS figures can often be very optimistic during bull markets whereas they reflect pessimism during bear markets. Exhibit 7 of the case shows, that Wal-Mart’s and Target’s projected P/E are higher than the S&P 500 estimate. I think 13.4 is a reasonable estimate for a projected forward looking P/E of Wal-Mart, therefore we can multiply the P/E multiple by the projected EPS for 2011 – this will give us a price estimate of the stock. 2010s EPS for Wal-Mart was $3.72. Assuming an earnings growth rate of 23.3%, which is the geometric average of the annual earnings growth rates, 2011s EPS estimate would equal: if we multiply the forward looking P/E multiple by this EPS estimate we get 2011 price estimate:

Thus the P/E multiple approach is valuing Wal-Mart’s stock price slightly above the recent closing price of $53.48. According to the P/E multiple approach (given our assumptions), Wal-Mart stock is undervalued. Even if the multiple is slightly off, it would still give us a undervaluation if the multiple is higher than 11.6 (at 11.6 the price estimate would equal the recent closing price). The high multiple figure is also a characteristic for Wal-Mart to be a growth stock. Recommendation According to the DDM, Three Stage Approach and the Multiple Approach, Wal-Mart is undervalued by at least $7/share. Even the more pessimistic approach has a higher theoretical price than the most recent closing price of $53.48. Hence my valuation leads to the same recommendation as Bloomberg’s analysts: Wal-Mart shares should be bought for the coming six to 12 month. Therefore Gupta should recommend Wal-Mart stock to new clients and existing clients who do not currently have Wal-Mart in their portfolios.