The Investment Prospects for Walmart

Investment Analysis Paper
The publicly traded company selected for this investment analysis paper is Walmart Stores, Inc. Walmart, an American multinational retail firm, is the largest retail chain worldwide by revenue. In particular, the global organization operates as a chain of grocery stores, hypermarkets, together with markdown department stores. The retailer was founded in the 1960s and has over the years extended its operations to more than 25 countries across the world, including North America, Latin America, Europe, and Asia. Walmart is also one of the most valuable firms in the world.
Evaluation of Walmart’s Board of Directors
Walmart Stores, Inc.’s board of directors have a great monitoring potential of assessing and examining the business operations. The amalgamation of the set of skills and the qualifications of the board members makes it possible to perceive that the board is in a great position to offer efficacious oversight and strategic guidance to the management of the company. Presently, there are 11 board members, 10 of who have senior level of leadership. With respect to strategy, there are four key areas in which the board considers oversight, which include retail, marketing or brand management, technology or e-commerce, and global business. It is imperative to note that in each of these areas, there are at least three board directors that offer oversight and monitoring with great expertise and specialty. More importantly, in the areas of governance, there is legal as well as finance and accounting, both of which have five board members who offer insight and guidance to the management of the company (Walmart, 2017).
Board representation ought to equitably mirror the trust that the society at large vests in a huge company such as Walmart Stores, Inc. with the authority to significantly influence the lives of several people within and outside the company. The manner in which Walmart’s board of directors is structured has both its strengths and weaknesses. One of the strengths is that the members of the board is made up of people who cooperatively provide a fitting poise of renowned and notable leadership, diverse perspectives, strategic set of skills, and specialized experience pertinent to the company’s business operations and strategic goals and objectives. All of them are carefully selected on the basis of excellent accomplishment in their professional careers, extensive experience and understanding, individual and professional reliability, capability to make self-determining, systematic inquiries, experience and comprehension of the business setting, preparedness and capability to dedicate sufficient time to Board responsibilities (Walmart, 2017). Another advantage is that in the past financial year, Walmart’s self-examination gave rise to altering the structure of the Board committees. In the previous financial years, the company had only one committee that was dedicated to the extensive scope of executive compensation, selections of the directors and governance. In the contemporary setting, these responsibilities and duties have presently been separated between two different committees, one being the Compensation and Management Development Committee and the other one being the Nominating and Governance Committee. The strong suit to this is that it brings about greater emphasis on management development in addition to the appointment and refreshment of the Board (Walmart, 2017). However, it is imperative to note that there are shortcomings and weaknesses. One of the downsides is that the board members constituted of 15 individuals, which made the process of decision making quite time consuming. At the same time, it is imperative to note that the board consists of three members who are part of the owning family, who are not necessarily experienced in a professional sense and therefore deemed not to make sensible decisions (Walmart, 2017).
Review of Income Statements and Balance Sheets
Walmart faces significant competition in the market from Target. In particular, Target is the second biggest discount store retailer in the United States, with Walmart taking the top spot. In the contemporary market, the company operates just over 1,800 retail stores all across the nation. In particular, Walmart finds its success in the market through the use of low prices as a strategy whereas its key competitor, Target, seeks to appeal to consumers that are younger and are conscious of their image. All investors wish to make the most of the returns on their investments in an organization. The return for an investor is measured by the return on equity. In particular, a DuPont analysis offers discernment and understanding into how a firm’s return on equity was generated through the breakdown of the return into three elements, which comprise of capital structure, operating efficiency, and asset effectiveness. DuPont Analysis is conducted using the following formula:
Operating Asset Capital Return on
Efficiency Effectiveness Structure Equity

Net Income/ Sales × Sales/ Assets × Assets/Equity = Net Income/Equity
Walmart DuPont Analysis 2017, 2016, 2016
i. Operations Efficiency = Net Income / Sales
2017 = 14,293 / 481,317 = 0.030
2016 = 15,080 / 478,614 = 0.032
2015 = 17,099 / 482,229 = 0.035
ii. Asset Effectiveness = Sales/ Assets
2017 = 481,317 / 198,825 = 2.42
2016 = 478,614 / 199,581 = 2.40
2015 = 482,229 / 203,490 = 2.37
iii. Capital Structure = Assets/Equity
2017 = 198,825 / 77,798 = 2.56
2016 = 199,581/ 80,546 = 2.48
2015 = 203,490 / 81,394 = 2.50
DuPont Analysis 2017 = 0.03 × 2.42 × 2.56 = 0.186 = 18.6%
DuPont Analysis 2016 = 0.032 × 2.40 × 2.48 = 0.190 = 19%
DuPont Analysis 2015 = 0.035 × 2.37 × 2.50 = 0.207 = 20.7%
Target DuPont Analysis 2017, 2016, 2015
i. Operations Efficiency = Net Sales/ Income
2017 = 2,737 / 69,495 = 0.039
2016 = 3,363 / 73,785 = 0.046
2015 = -1,636 / 72,618 = -0.023
ii. Asset Effectiveness = Sales/ Assets
2017 = 69,495 / 37,431 = 1.86
2016 = 73,785 / 40,262 = 1.83
2015 = 72,618 / 41,172 = 1.76
iii. Capital Structure = Assets/Equity
2017 = 37,431 / 10,953 = 3.42
2016 = 40,262 / 12,957 = 3.11
2015 = 41,172 / 13,997 = 2.94
DuPont Analysis 2017 = 0.039 × 1.86 × 3.42 = 0.248 = 24.8%
DuPont Analysis 2016 = 0.046 × 1.83 × 3.11 = 0.262 = 26.2%
DuPont Analysis 2015 = -0.023 × 1.76 × 2.94 = 0.119 = 11.9%
The information used in the calculations above were obtained from the company’s annual financial statements. One of the trends perceived is that the ratio of capital structure for Target is higher than Walmart, which implies that Target finances its assets with debt rather than equity whilst Walmart finances its assets with equity rather than debt. In addition, this means that Target has higher financial leverage and a capital structure that is riskier. With respect to asset effectiveness, Walmart has higher ratios. This implies that the company is more efficacious in generating sales from its assets. Lastly, with regard to operating efficiency, there is significant competition between the two companies, but Target slightly edges Walmart, which shows that in the past three years, it has been more efficient in generating sales into profits (Godwin and Alderman, 2010). The key difference noted is that in the 2016 and 2017 fiscal years, Target had a higher return on equity compared to Walmart. Based on the calculations above, the ROE of Walmart constantly declined in the three years, from 20.7% in 2015 to 19% in 2016, and further down to 18.6% in 2017. In contrast, the ROE of Target showed improvement. The ratio increased from 11.9% in 2015 to 26.2% in 2016 but slightly declined to 24.8% in 2017. The analysis shows that in general, Target was more efficient in generating returns for the shareholders’ equity in comparison to Walmart.
Dividend Discount Model
The Dividend Discount Model (DDM) is formula of valuation in investment that is employed to determine the fair value of a dividend stock. The underlying notion within the model is that it is the succeeding year’s expected divided by a suitable discount rate less the expected dividend growth rate. The model takes into account the notion that the asset’s fair value is the totality of its future cash flows being discounted back to fair value using a suitable and fitting discount rate (Damodaran, 2007). The formula use is as follows:
P = D1 / (r –g)
Based on Walmart’s annual income statement, the current dividend per share is $2. The dividend per share in 2016 was $1.96 and $1.92 in 2015. This indicates a growth rate of 2.10% per annum.
The Cost of Equity can be computed using the following formula:
Cost of Equity = (Dividends per share for next year / Current Market Value of Stock) + Growth rate of dividends (Vaidya, 2017).
Dividends per share for next year = 2 × (1 + 2.10%) = $2.04
Current Market Value of Stock = $78.37
Therefore, cost of equity = (2.04 / 78.37) + 2.10% = 2.13%
Remember, P = D1 / (r –g) = 2.04 / (2.13% – 2.10%)
= 2.04 / 0.03% = 2.04 / 0.0003
= $6,800
The number I arrived at for the intrinsic value does not appear to be feasible or logical. I did face a number of problems or issues while using the dividend growth model. In particular, it was difficult to determine the cost of equity that is imperative in determining the intrinsic value. Walmart Stores, Inc. does pay a dividend and has done so at least for the past three financial years. It is not always reasonable or logical to assume a constant growth for the company. This is largely for the reason that making such an assumption would be wrong. For instance, it would be illogical to say that a company has been constantly growing at a rate of 10 percent while the economy in general has been growing at a rate of 3 percent or 4 percent in the same number of years. As a result, this makes the assumption for the formula (r-g) to be wrong and therefore the calculation being entirely wrong.
Analysis of Real Options
In definition, an option is considered to be a right but not an obligation, to take a particular future action that is already specified at a cost that is already specified. Real options were invented by Myers and this generated the aspect of financial options in the world of strategic decision making. Real options are perceived as prospects to buy real assets on conceivably satisfactory terms. These promising terms depend on adjustment outlays, market power, or other deficiencies in product or factor markets (Trigeorgis and Reuer, 2017). The value of a project can be accomplished by utilizing a diversity of real options. These consist of timing options, staging options, exit options, operating options, flexibility options, and growth options.
The potential real options include operating options, growth options, and flexibility options. These options are both industry specific and company specific. It is imperative to note that Walmart operates in more than 25 nations across the world and therefore can experience, for instance, the opportunity to invest in the expansion of its business operations with respect to opening more retail stores. These options largely have an impact on the company’s capital budgeting process. This is in the sense that the real options generate economic values by creating future decision rights for Walmart Stores’ management team. For instance, growth opportunities coming to Walmart are investments that are made not just for the instantaneous cash flows emanating from the project in question, but at the same time also made for the economic value that is derived from the succeeding investment prospects.
Risk Potential and Rate of Return (Capital Asset Pricing Model)
The capital asset pricing model (CAPM) is delineated as a model that computes the expected return on the basis of the rate of return on the market, the beta coefficient of the stock, and the risk-free rate. The model acknowledges that an investor ought to anticipate to be sufficiently recompensed both for having made an investment in a certain security as well as for the risk of that particular security, with superior risk necessitating superior returns. The formula used in calculating the expected rate of return is as follows:
E (R) = Rf + ß (Rmarket – Rf)
The risk free rate of return is 2.080%
The beta coefficient of the stock is 0.30
Market rate = 13.85%
E (R) = 2.080 + 0.3 (13.85 – 2.080)
= 5.61%
Therefore, the expected return for your company using CAPM is 5.61%
The estimated required rate of return using the dividend discount model is 2.13%. In comparison to the CAPM expected rate of return figure, this is significantly lower.
Weighted Average Cost of Capital (WACC) in Capital Budgeting
The cost of capital for a company is a weighted average of the costs of the different kinds of financing utilized by a firm. The weights are the quantities of the total firm value that is represented by the different sorts of financing. By weighing the costs of the particular individual financial categories in this manner, then it becomes conceivable to accomplish the general average opportunity cost of every unit of currency that is invested in the company (Moles et al., 2011). Weighted Average Cost of Capital is delineated as a weighted average cost of equity, cost of debt, and cost of preference share, with the weights being the proportion of capital that is sourced from each of the aforementioned components for the firm as a whole. For a firm that has two sources of finance being debt and equity, then the calculation of the weighted average cost of capital is calculated using the following formula:
WACC = kFirm = xDebtkDebt + xEquitykEquity


The rate of taxation is estimated from the company’s income statement.
Rate of taxation = provisions for income taxes / income from continuing operations before income taxes × 100
= 6,204 / 20,497 × 100
= 30.27 percent
i. The cost of debt capital is similar to the actual or ascribed interest rate on the firm’s debt, attuned for the tax deductibility of interest expenses. In particular:
The after-tax cost of debt capital = The Yield to Maturity on long-term debt × (1 – tax rate) (Brigham and Houston, 2012).
= 3.7 × (1 – 0.3027)
= 3.7 × (0.6973)
=2.58
ii. The cost of equity of a company encompasses a weighted average of the costs of the various kinds of outstanding stock that the company has at a certain point in time. This includes the common stock and the preferred stock.
There are different approaches that can be used to calculate the costs of common stock. One of these approaches is the Capital Asset Pricing Model (CAPM). In particular, the equation used in this approach is: E(Ri) = Rrf + ?i[E(Rm) – Rrf] (Ehrhardt and Brigham, 2016). As calculated above, the expected rate of return is 5.61 percent.
Preferred stocks are set in the middle of bonds and stocks. Theoretically, they are referred to as equity securities. On the other hand, they have numerous comparable characteristics to debt instruments. The issuance of preferred stock is undertaken with a fixed par value and the dividends paid out to preferred stockholders is undertaken based on a percentage of that par value at a fixed rate (Ehrhardt and Brigham, 2016). Walmart Stores, Inc. does not issue preference shares and therefore the cost of preferred shares is zero.
Therefore, WACC is calculated as follows:
Total equity used in this calculation is the market value of stock (number of shares times the current stock price), which is $80,535. The debt used in the calculation is the book value of long-term debt obtained from the balance sheet, which is $36,015.
Weight of equity = 80,535 / (80,535 + 36,015) = 0.69 = 69%
Weight of debt = 36,015 / (80,535 + 36,015) = 0.31 = 31%
WACC = xDebtkDebt + xEquitykEquity
= (0.31 × 2.58%) + (0.69 × 5.61%)
= 4.67%
As a result, the average cost of Walmart Stores, Inc.’s financing, its WACC, is 4.67 percent, which signifies the average rate of return the company must earn on its prevailing investments to make sure the value of the firm does not decline.
If the company uses this WACC in the process of capital budgeting, for instance, as the discount rate in the calculation of Net Present Value (NPV) and Internal Rate of Return (IRR), there are a number of assumptions that are being made. One of the key assumptions is that there is no change in the capital structure. Basically, there ought to be a similarity between the structure of the new project investment, also referred to as the capital mix, and the prevailing company structure. The implication of this is that if the company has a ratio of debt to equity that is 70:30 in their most recent balance sheet, an addition of the new project will uphold the same. Another assumption made is that there is no alteration in the risk of new projects. In particular, the risk that is linked with the new project will be similar to the prevailing projects. For instance, if a company opts to expand its operations and increases the number of manufacturing machines from 100 to 150, bearing in mind that the business and the industry are akin to each other, there will be just about no alteration in the risk profile of the prevailing business and the new expansion (Borad, 2017).
There are difficulties that the company faces in making use of this rate. One of the challenges is the difficulty in upholding and preserving the capital structure. In particular, the supposition to be made that the capital structure does not change has infrequent prospects of being maintained at all times. It gives the suggestion that the capital structure ought to be maintained all through, which is feasible and therefore shows the need for adjusting the WACC in view of that. Another challenge that arises encompasses the aspect of accepting bad projects and declining good projects. It is imperative to note that the supposition that there is no change or adjustment to the risk profile of new projects does have its own shortcomings. This is largely for the reason that risk of a project is influenced by a range of several factors. Taking this into consideration, making the supposition that there is no change in the risk profile of new projects would be largely impractical (Borad, 2017). In addition, there is the problem in the acquisition of present-day market cost of capital. The WACC employed for assessing new projects necessitate taking into account the existing cost of capital and understanding these kinds of costs as problematic. In particular, WACC for Walmart Stores, Inc. takes into consideration equity and debt. However, it is important to understand that the interest cost of debt continues to fluctuate in the market contingent to the changes in the economy (Borad, 2017).
Mix of Debt and Equity
In definition, capital structure takes into account the mixture of a company’s financing that is used to fund the day to day business operations. These sources of finance can come from equity, debt, in addition to a mixture of securities. With respect to equity, the funds come from common stock and preferred stock whereas for debt, the funds come from short-term and long-term funds (Moles et al., 2011).
Weight of equity = 80,535 / (80,535 + 36,015) = 0.69 = 69%
Weight of debt = 36,015 / (80,535 + 36,015) = 0.31 = 31%
Based on the information obtained from Walmart’s financial statements, the capital structure of the company is 70 percent for equity and 30 percent for debt. It is imperative to note that the company does not issue preferred shares. The implication of this is that Walmart employs more of equity than debt in financing its assets. It means that the company has a high leverage ratio and has a capital structure that is less conservative and more aggressive. As a result, the downside to this capital structure is that the company experiences lower growth rates, which can be perceived in the growth of Walmart in the recent financial period.
Walmart Stock Performance
Walmart has a proven performance in accordance to the stock market information from the New York Stock Exchange. WMT has a market capitalization of $USD 243.98 billion. The company’s stock is presently trading at $79.46 with a P/E ratio of 19.12 and an EPS of 1.17. In accordance to its price history chart, Walmart Stores, Inc.’s stock has recorded a high of over $79.80 and lows of $78.37. Therefore, based on this current stock performance, the future profitability of the company can easily be predicted. The performance of the company at the stock market is likely to be on an upward trend in the foreseeable future. The firm is expected to register an increased dividend growth rate which means an increase in its dividend per share. Stock prices increase with earnings (Yahoo Finance, 2017). The company’s P/E ratio as stated, sits at 19.12 which is considerably favorable in the normal range of 12 to 25 but even with this, Walmart Stores, Inc. has sufficient growth prospects. On the basis of industry statistics, the average P/E ratio in the retail industry presently stands at 36.6. This means that the company operates in a highly competitive industry and as such more needs to be done to raise its performance to the industry level (Yahoo Finance, 2017). In conclusion, I would recommend to an investor to invest in Walmart Stores, Inc.


References
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