Author: Rocco Huang
Covestor model: Tortoise and the Hare
Disclosure: Long WMT, MSFT, INTC, MDT, GILD
In a recent article in Smart Money magazine entitled “Dead Stocks Walking”, Russell Pearlman lamented the disappointing and puzzling performance of Wal-Mart (WMT) shares, along with many other high-quality blue chips (e.g., Microsoft, Intel, Medtronic, Gilead) in the past decade.
Many asset managers, some considering themselves “value investors,” now say that WMT is a “value trap,” citing the contrast between its flatline performance in the stock market and its consistently growing earnings in the past decade.
Their explanation is a typical example of selective memory loss. Ten years ago, WMT was emphatically not a value stock. According to Gurufocus, WMT’s P/E ratio was above 40X ten years ago, and since has been declining steadily.
They simply paid too much for it. Buying-and-holding a glamour stock is not value investing. Over time, a glamour stock may become a value stock as its price comes down, but it doesn’t change the fact that, when they purchased WMT back then it was an overvalued glamour stock.
Of course, WMT’s share price should have gone nowhere. We are still paying for the sins of the last large-cap equity bubble of 1982-2000, more than 11 years after its collapse. Yes, it takes that long, when the two decades of accumulated overvaluation was that much.
However, WMT is not a “value trap”. A “value trap” is a stock whose price initially appears cheap based on its perceived fundamental at the time of purchase, but later turns out to be expensive when its fundamentals reveal it to be in much worse shape. In contrast, WMT in the past decade was simply an over-hyped growth stock finding its way down to its intrinsic value. Its fundamentals didn’t collapse. Quite the opposite.
Those who purchased WMT ten years ago can only blame themselves for paying too much. In investing, buying at a bargain price can hide a lot of sins. Now, after ten years, why is WMT a buy again? First of all, the Wal-Mart of today remains as high quality a company as the Wal-Mart ten years ago. Wall Street analysts back then were right about the company, but wrong about its price.
Its market price has changed. The stock market is like a pendulum. Gravity makes a clock pendulum swing back and forth. In investing, the counterpart of the gravity theory in physics is the law of mean reversion. Crowd sentiment swings between two extremes: greed and fear. Stock prices swing between overvaluation and undervaluation.
How do I know that now is the time to buy? (I am sure some of you have in your mind a clock-related joke: “A dead clock can be right twice a day.”)
My first answer is that I don’t know. A stock’s price reaches its intrinsic value from time to time, but similar as a pendulum, it seldom spends much time there. If you have ever observed a pendulum clock doing its work, you must have noticed that the pendulum spends the least time at the nadir, because its speed is the fastest there. Timing the market is difficult, if not futile.
Trading volumes are usually the lowest when a stock bottoms, suggesting that indeed very few market participants actually know they are at the bottom.
My second answer is that I do know something. Value investors believe in the laws of gravity and mean-reversion. The investing process of value investors consists of two stages. First, we wait patiently (like ten years in the case of Wal-Mart) for a stock to become cheap enough. Second, we hold our hands out in the path of the pendulum, and wait again (hopefully not another ten years) for it to return and hit us.
It may take a while. Like a pendulum, an over-valued stock usually has to become significantly under-valued first before bouncing back and passing its intrinsic value for a second time. The silver lining is that, for a high quality company that is growing just moderately every year, it pays to wait. Just imagine a pendulum bob that is growing in weight every second.
I don’t attempt to time the market, but I would like to point out that Smart Money magazine is a great contrarian indicator. (To be fair, I believe all popular magazines make great contrarian indicators.) The icing on the cake is the last paragraph of the article discussing the recent exit decision of a fund manager:
Notably, however, he did finally throw in the towel this year on one of his longtime holdings: Wal-Mart. After seven years, the manager concluded that the retailer had become a “value trap” — which is to say that while it looked like it could become a great stock, the odds weren’t good that it ever would. “Wal-Mart hasn’t moved out of a range in 10 years,” Creech says. “When you think like that, it becomes very easy to unload.”
