Valuing Wal-Mart Case Analysis

Ted Palumbo

Professor Mullen

Investments

1 February 2015

Valuing Wal-Mart Case Analysis

We recommend that investors who currently own Wal-Mart stock hold but we do not recommend buying more stock. For those investors that do not currently own Wal-Mart stock, we would recommend buying the stock. Our evaluation of the Dividend Discount Model with a discount rate using a two-year beta and an initial growth rate of EPS over two years provided us with an intrinsic value of $80.20, while the Dividend Discount Model with a discount rate using a five-year beta and an initial growth rate of EPS over five years gave us an intrinsic value of $80.84. The CAPM with a two-year beta gave us $60.87 for an intrinsic value, while the CAPM with a five-year beta gave us $54.50 for an intrinsic value. Our expected EPS analysis was $64.54 and our price to earnings analysis gave us $58.12 for an intrinsic value. Since Wal-Mart’s stock is currently valued at $53.48, all of the valuation approaches that we used led us to the same conclusion, that Wal-Mart stock is undervalued. The financial statements lead us to believe that the company is strong and will make for a good long-term investment.

In order for us to have the data required to run a Dividend Discount Model or a Capital Asset Pricing Model, we needed to first calculate beta. Using Bloomberg, we created two models that both produced an adjusted beta value. The period for both models was weekly. The first model is shown in Figure 1 and looked at data from 2/01/08 to 1/29/10 (two years). This model produced an adjusted beta value of 0.655. The second model is shown in Figure 2 and looked at data from 2/01/05 to 1/29/10 (five years). This model produced an adjusted beta value of 0.701.

The first tool that we used to estimate an intrinsic value for Wal-Mart’s stock is the Capital Asset Pricing Model. The case provides us with the following inputs: the dividend growth (g = 5.0%), the expected dividend (D = $1.21), the market risk premium (5.05%), and the risk free rate (3.68%). For this CAPM, we used the two-year beta (0.655) found in Figure 1. We then calculated the investor’s required rate of return (Ke) using the CAPM.

The CAPM gives us: Ke = 0.0368 + (0.655 x 0.0505) = 6.98775%

We have P = 1.21 / (0.0698775 - 0.05) = $60.87

We know that February 2010 closing price was $53.48 per share so it means that Wal-Mart is slightly undervalued and is a good investment opportunity.

We reran the CAPM using the five-year beta (0.701) that we found from Figure 2 and the results are below.

The CAPM gives us: Ke = 0.0368 + (0.701 x 0.0505) = 7.22005%

We have P = 1.21 / (0.0722005 - 0.05) = $54.50

We know that February 2010 closing price was $53.48 per share so it means that Wal-Mart is slightly undervalued by $1.02.

        Another tool that we used to estimate the intrinsic value of Wal-Mart’s stock was the Dividend Discount Model (DDM). There were seven variables that we had to input into the model to find a theoretical price for Wal-Mart’s stock. We created two different DDMs—the only variables that were different between the two models were the discount rate and the initial growth rate of EPS.

The first model, which is shown in Figure 3, had a discount rate (r) of 6.98775%. We found the discount rate by using the Capital Asset Pricing Model. For the CAPM, we used the equation Ke (r) = .0368 + (.655 x .0505). The 0.655 is the two-year adjusted beta, which was taken from Figure 1. This calculation gives us the discount rate, which is .0698775 or 6.98775%.

We found that the trend of Wal-Mart’s historical P/E was increasing from 1994 to 1999. After 1999, Wal-Mart’s P/E decreased through 2009. From this information, we concluded that Wal-Mart grows for six years, and then goes into a transition period for eleven years. After the completion of the transition period, Wal-Mart will go into maturity.

Investment Advisor, Sabrina Gupta, provided us with the following data: the payout rate at maturity of 45%, the current fiscal year EPS of 3.72, and the current calendar year dividend of 1.09. 

We then needed to determine the initial growth rate of EPS. For the two-year beta DDM, we decided to calculate the change in EPS over the past two years (from 2008 to 2009, then from 2009 to 2010, then took the average). This calculation was: 2009 of 3.35 – 2008 of 3.16 = .19 → 

.19 / 3.16 = .06012658    then 2010 of 3.72 – 2009 of 3.35 = .37 → .37 / 3.35 = .11044776

then .06012658 + .11044776 = .17057434 / 2 = .08528717 x 100 = 8.52871706%

After we determined all of the necessary values, we inserted them into our Dividend Discount Model and found that the theoretical stock price for Wal-Mart is $80.20 per share. Since Wal-Mart’s official closing stock price in February 2010 was $53.48 per share, we concluded that this model shows that Wal-Mart’s stock price is clearly undervalued. This model shows that we would expect Wal-Mart’s stock price to be around $80.20, therefore we would recommend buying Wal-Mart stock because our expectation is that the stock price will increase as these models show.