Paying too much for a wonderful stock can be hazardous to one's bottom line

By DAVID MOON, Moon Capital Management
September 1, 2002

In 1993, I sold Wal-Mart stock at a loss. At the time, I was convinced I was the only person in the world to ever sell Wal-Mart at a loss. I purchased it in 1993 at $17 a share. (All prices in this column are adjusted for stock splits.) The company was growing both quickly and profitably. From 1968 until 1992, Wal-Mart's earnings had increased from $482 thousand to $1.6 billion - an annualized growth rate of 42 percent.

How in the world did I lose money in Wal-Mart?

I didn't lose the money when I sold it; I guaranteed my loss when I bought the stock.

Two months after my purchase, I attended a retail analyst conference. Five hundred men in gray suits crammed into the ballroom of a Chicago hotel. (This was before female analysts and business casual attire.) Every speaker, regardless of his assigned or intended topic, ended almost every paragraph with the same phrase: "Like Wal-Mart."

"The winners in the convenience store industry are going to be the people who can become the low-cost providers in their respective markets, like Wal-Mart."

"To compete in consumer electronics, retailers have to develop pricing leverage with their vendors, like Wal-Mart."

'Grocery stores are finding ways to expand their customers' shopping habits within their stores - and trying to increase the number of visits their customers make to the store each week, like Wal-Mart."

I don't know if I learned much about grocery stores or home electronics retailers at that meeting, but I did learn one thing about Wal-Mart: everybody loved it. How could you not own the company? Every smart person in the retail business just spent two days telling us that Wal-Mart was the sine qua non of the retail business.

I went home and sold my Wal-Mart shares. At a loss. I decided that if many people thought Wal-Mart was the best thing since sliced bread, surely there was a bit of emotion factored into the stock price. When I returned to my office, I tried to look at Wal-Mart from a logical standpoint, not emotional.

In 1992, Wal-Mart earned $1.6 billion on $44.2 billion in revenues. If you assume that in 20 years Wal-Mart's revenue growth would slow to something more closely resembling the overall growth in the economy, the company would have to continue its 42 percent historic growth for the next 20 years in order to justify its stock price in 1993.

The only problem with that assumption however, is that if Wal-Mart maintained a 42 percent growth rate from 1993 to 2013, Wal-Mart's revenues would be $62.2 trillion in 2013. At a three-percent growth rate, the Gross Domestic Product of the entire United States would only be $12 trillion in 2013. The market implicitly assumed Wal-Mart's revenues would be five times the total economic output of the entire United States.

By 1996, Wal-Mart's stock price had declined almost 70 percent from my initial purchase price. It took almost five years for Wal-Mart to fully recover.

(Wal-Mart now trades above $50 a share, up about 200 percent from my original purchase. The Dow Jones Industrial Average increased about the same percent over that period.)

Since almost everyone owned Wal-Mart in 1993, investors decided the only risk was in not owning the stock. Institutional investors were worse than individuals. For pension plans and mutual funds, there was practically no risk in owning Wal-Mart, because if they lost money on their investment, no one could criticize the institutional managers; everybody else owned Wal-Mart, too.

There wasn't anything wrong with Wal-Mart from 1993 to 1997. They continued to open stores, hire employees and make more money. But the stock price was simply too high. It took almost five years for the earnings of the company to "catch up" to the point where the stock was once again cheaply priced.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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