How Telltales Told You Not to Own Wal-Mart, and Continue To Do So

How Telltales Told You Not to Own Wal-Mart, and Continue To Do So

Wal-Mart market value took a huge drop on Wednesday.  In fact, the worst valuation decline in its history.  That decline continued on Thursday.  Since the beginning of 2015 Wal-Mart has lost 1/3 of its value.  That is an enormous ouch.

WMT stockBut, if you were surprised, you should not have been.  The telltale signs that this was going to happen have been there for years.  Like most stock market moves, this one just happened really fast.  The “herd behavior” of investors means that most people don’t move until some event happens, and then everyone moves at once carrying out the implications of a sea change in thinking about a company’s future.

All the way back in October, 2010 I wrote about “The Wal-Mart Disease.”  This is the disease of constantly focusing on improving your “core” business, while market shifts around you increasingly make that “core” less relevant, and less valuable.  In the case of Wal-Mart I pointed out that an absolute maniacal focus on retail stores and low-cost operations, in an effort to be the low price retailer, was being made obsolete by on-line retailers who had costs that are a fraction of Wal-Mart’s expensive real estate and armies of employees.

At that time WMT was about $54/share.  I recommended nobody own the stock.

In May, 2011 I reiterated this problem at Wal-Mart in a column that paralleled the retailer with software giant Microsoft, and pointed out that because of financial machinations not all earnings are equal.  I continued to say that this disease would cripple Wal-Mart.  Six months had passed, and the stock was about $55.

By February, 2012 I pointed out that the big reorganization at Wal-Mart was akin to re-arranging deck chairs on a sinking ship and said nobody should own the stock.  It was up, however, trading at $61.

At the end of April, 2012 the Wal-Mart Mexican bribery scandal made the press, and I warned investors that this was a telltale sign of a company scrambling to make its numbers – and pushing the ethical (if not legal) envelope in trying to defend and extend its worn out success formula.  The stock was $59.

Then in July, 2014 a lawsuit was filed after an overworked Wal-Mart truck driver ran into a car killing James McNair and seriously injuring comedian Tracy Morgan.  Again, I pointed out that this was a telltale sign of an organization stretching to try and make money out of a business model that was losing its ability to sustain profits.  Market shifts were making it ever harder to keep up with emerging on-line competitors, and accidents like this were visible cracks in the business model.  But the stock was now $77. Most investors focused on short-term numbers rather than the telltale signs of distress.

In January, 2015 I pointed out that retail sales were actually down 1% for December, 2014.  But Amazon.com had grown considerably.  The telltale indication of a rotting traditional retail brick-and-mortar approach was showing itself clearly.  Wal-Mart was hitting all time highs of around $87, but I reiterated my recommendation that investors escape the stock.

By July, 2015 we learned that the market cap of Amazon now exceeded that of Wal-Mart.  Traditional retail struggles were apparent on several fronts, while on-line growth remained strong.  Bigger was not better in the case of Wal-Mart vs. Amazon, because bigger blinded Wal-Mart to the absolute necessity for changing its business model.  The stock had fallen back to $72.

Now Wal-Mart is back to $60/share.  Where it was in January, 2012 and only 10% higher than when I first said to avoid the stock in 2010.  Five years up, then down the roller coaster.

From October of 2010 through January, 2015 I looked dead wrong on Wal-Mart.  And the folks who commented on my columns here at this journal and on my web site, or emailed me, were profuse in pointing out that my warnings seemed misguided.  Wal-Mart was huge, it was strong and it would dominate was the feedback.

But I kept reiterating the point that long-term investors must look beyond short-term reported sales and earnings.  Those numbers are subject to considerable manipulation by management. Further, short-term operating actions, like shorter hours, lower pay, reduced benefits, layoffs and gouging suppliers can all prop up short-term financials at the expense of recognizing the devaluation of the company’s long-term strategy.

Investors buy and hold.  They hold until they see telltale signs of a company not adjusting to market shifts.  Short-term traders will say you could have bought in 2010, or 2012, and held into 2014, and then jumped out and made a profit.  But, who really can do that with forethought?  Market timing is a fools game.  The herd will always stay too long, then run out too late.  Timers get trampled in the stampede more often than book gains.

In this week’s announcement Wal-Mart executives provided more telltale signs of their problems, and the fact that they don’t know how to fix them, and therefore won’t.

  • Wal-Mart is going to spend $20B to buy back stock in order to prop up the price.  This is the most obvious sign of a company that doesn’t know how to keep up its valuation by growing profits.
  • Wal-Mart will spend $11B on sprucing up and opening stores.  Really.  The demand for retail space has been declining at 4-6%/year for a decade, and retail business growth is all on-line, yet Wal-Mart is still massively investing in its old “core” business.
  • Wal-Mart will spend $1.1B on e-commerce.  That is the proverbial “drop in the competitors bucket.” Amazon.com alone spent $8.9B in 2014 growing its on-line business.
  • Wal-Mart admits profits will decline in the next year.  It is planning for a growth stall.  Yet, we know that statistically only 7% of companies that have a growth stall ever go on to maintain a consistent growth rate of a mere 2%.  In other words, Wal-Mart is projecting the classic “hockey stick” forecast.  And investors are to believe it?

The telltale signs of an obsolete business model have been present at Wal-Mart for years, and continue.

In 2003 Sears Holdings was  $25/share.  In 2004 Sears bought K-Mart, and the stock was $40. I said don’t go near it, as all the signs were bad and the merger was ill-conceived.  Despite revenue declines, consistent losses, a revolving door at the executive offices and no sign of any plan to transform the battered, outdated retail giant against growing on-line competition investors believed in CEO Ed Lampert and bid the stock up to $77 in early 2011. (I consistently pointed out the telltale signs of trouble and recommended selling the stock.)

By the end of 2012 it was clear Sears was irrelevant to holiday shoppers, and the stock was trading again at $40.  Now, SHLD is $25 – where it was 12 years ago when Mr. Lampert started his machinations.  Again, only a market timer could have made money in this company.  For long-term investors, the signs were all there that this was not a place to put your money if you want to have capital growth for retirement.

There will be plenty who will call Wal-Mart a “value” stock and recommend investors “buy on weakness.”  But Wal-Mart is no value.  It is becoming obsolete, irrelevant – increasingly looking like Sears.  The likelihood of Wal-Mart falling to $20 (where it was at the beginning of 1998 before it made an 18 month run to $50 more than doubling its value) is far higher than ever trading anywhere near its 2015 highs.

Why You Don’t Want To Own IBM

Why You Don’t Want To Own IBM

IBM had a tough week this week.  After announcing earnings on Wednesday IBM fell 2%, dragging the Dow down over 100 points.  And as the Dow reversed course to end up 2% on the week, IBM continued to drag, ending down almost 3% for the week.

Of course, one bad week – even one bad earnings announcement – is no reason to dump a good company’s stock.  The short term vicissitudes of short-term stock trading should not greatly influence long-term investors.  But in IBM’s case, we now have 8 straight quarters of weaker revenues.  And that HAS to be disconcerting.  Managing earnings upward, such as the previous quarter, looks increasingly to be a short-term action, intended to overcome long-term revenues declines which portend much worse problems.

This revenue weakness roughly coincides with the tenure of CEO Virginia Rometty.  And in interviews she increasingly is defending her leadership, and promising that a revenue turnaround will soon be happening.  That it hasn’t, despite a raft of substantial acquisitions, indicates that the revenue growth problems are a lot deeper than she indicates.

ibm4-1

CEO Rometty uses high-brow language to describe the growth problem, calling herself a company steward who is thinking long-term.  But as the famous economist John Maynard Keynes pointed out in 1923, “in the long run we are all dead.”  Today CEO Rometty takes great pride in the company’s legacy, pointing out that “Planes don’t fly, trains don’t run, banks don’t operate without much of what IBM does.”

But powerful as that legacy has been, in markets that move as fast as digital technology any company can be displaced very fast.  Just ask the leadership at Sun Microsystems that once owned the telecom and enterprise markets for servers – before almost disappearing and being swallowed by Oracle in just 5 years (after losing $200B in market value.)  Or ask former CEO Steve Ballmer at Microsoft, who’s delays at entering mobile have left the company struggling for relevancy as PC sales flounder and Windows 8 fails to recharge historical markets.

CEO Rometty may take pride in her earnings management.  But we all know that came from large divestitures of the China business, and selling the PC and server business.  As well as significant employee layoffs.  All of which had short-term earnings benefits at the expense of long-term revenue growth.  Literally $6B of revenues sold off just during her leadership.

Which in and of itself might be OK – if there was something to replace those lost sales.  (Even if they didn’t have any profits – because at least we have faith in Amazon creating future profits as revenues zoom.)

What really worries me about IBM are two things that are public, but not discussed much behind the hoopla of earnings, acquisitions, divestitures and all the talk, talk, talk regarding a new future.

CNBC reported (again, this week,) that 121 companies in the S&P 500 (27.5%) cut R&D in the first quarter.  And guess who was on the list?  IBM, once an inveterate leader in R&D has been reducing R&D spending.  The short-term impact?  Better quarterly earnings.  Long term impact????

The Washington Post reported this week about the huge sums of money pouring out of corporations into stock buybacks rather than investing in R&D, new products, new capacity, enhanced marketing, sales growth, etc.  $500B in buybacks this year, 34% more than last year’s blistering buyback pace, flowed out of growth projects. To make matters worse, this isn’t just internal cash flow going for buybacks, but companies are actually borrowing money, increasing their debt levels, in order to buy their own stock!

And the Post labels as the “poster child” for this leveraged stock-propping behavior…. IBM.  IBM

“in the first quarter bought back more than $8 billion of its own stock, almost all of it paid for by borrowing. By reducing the number of outstanding shares, IBM has been able to maintain its earnings per share and prop up its stock price even as sales and operating profits fall.

The result: What was once the bluest of blue-chip companies now has a debt-to-equity ratio that is the highest in its history. As Zero Hedge put it, IBM has embarked on a strategy to “postpone the day of income statement reckoning by unleashing record amounts of debt on what was once upon a time a pristine balance sheet.”

In the case of IBM, looking beyond the short-term trees at the long-term forest should give investors little faith in the CEO or the company’s future growth prospects.  Much is being hidden in the morass of financial machinations surrounding acquisitions, divestitures, debt assumption and stock buybacks.  Meanwhile, revenues are declining, and investments in R&D are falling.  This cannot bode well for the company’s long-term investor prospects, regardless of the well scripted talking points offered last week.

 

 

Why Apple is worth more than Wal-Mart – it’s about the future, not the past


Apple’s market value has struggled in 2011.  When I ask people why, the overwhelming top 3 responses are:

  • How can a company nearly bankrupt 10 years ago become the second most valuable company on the equity market?
  • Apple has had a long run, isn’t it about to end?
  • How can Apple be worth so much, when it has no “real” assets?

I’m struck by how these questions are based on looking backward, rather than looking into the future.

Firstly, it doesn’t matter where you start, but rather how well you run the race.  What happened in the past is just that, the past.  Changing technologies, products, solutions, customers, business practices, economic conditions and competitors cause markets to shift.  When they shift, competitor positions change.  The strong can remain strong, but it’s also possible for company’s fortunes to change drastically. Apple has taken advantage of market shifts – even created them – in order to change its fortunes.  What investors should care about is the future.

Which leads to the second question; and the answer that there’s no reason to think Apple’s growth run will end any time soon.  Perhaps Apple won’t maintain 100% annual growth forever, but it doesn’t have to grow at that rate to be a very valuable investment.  And worth a lot more than the current value.  That Apple can grow at 20% (or a lot more) for another several years is a very high probability bet:

  1. Apple’s growth markets are young, and the markets themselves are growing fast.  Apple is not in a gladiator war to maintain old customers, but instead is creating new customers for digital/mobile entertainment, smartphones and mobile tablets.  Because it is in high growth markets it’s odds of maintaining company growth are very good.  Just look at the recent performance of iPad tablet sales, a market most analysts predicted would struggle against cheaper netbooks.  Quarterly sales are blowing past early 2010 estimates of annual sales, and are 250% over last year (chart source Silicon Alley Insider): IPad Sales 2Q 2011
  2. Apple’s products continue to improve.  Apple is not resting upon its past success, but rather keeps adding new capability to its old offerings in order to migrate customers to its new platforms.  At the recent developer’s conference,for example, Apple described how it was adding Twitter integration for enhanced social media to its platforms and introducing its own messenger service, bypassing 3rd party services (like SMS) and replacing competitive products like RIM’s BBM. 
  3. Further, Apple is introducing new solutions like iCloud (TechStuffs.netApple iCloud Key Features and Price)  offering free wireless synching between Apple platforms, free and seamless back-ups, and the ability to operate without a PC (even Mac flavor) if you want to be mobile-only (“The 10 Huge Things Apple Just RevealedBusinessInsider.com).  These solutions keep expanding the market for Apple sales into new markets –  such as small businesses (Entrepreneur.comWhat Lion Means for Small Business“) as it solves unmet needs ignored by historically powerful solutions providers, or offered at far too high a price.

Thirdly, investors wonder how a company can be worth so much without much in the way of “real” assets.  The answer lies in understanding how the business world has shifted.  In an industrial economy real assets – like land, building, machinery – was greatly valued.  They were the means of production, and wealth generation.  But we have transitioned to the information economy.  Now the information around a business, and providing digital solutions, are worth considerably more than “real” assets. 

How many closed manufacturing plants, retail stores or restaurants have you seen?  How many real estate developers have shuttered?  Contrarily, what’s the value of customer lists and customer access at companies like Amazon.com, GroupOn, Linked-In, Twitter and Facebook in today’s information economy?  What’s the demand for printed books, and what’s the demand for ebooks (such as Kindle?)  “Real” asset values are tumbling because they are easy to obtain, and owning them produces precious little value, or profit, in today’s globally competitive economy. 

This same week that Apple announced a barrage of revenue-generating upgrades and new products asset rich Wal-Mart made an announcement as well.  After a decade in which Apple’s value skyrocketed to over $330B (More than Microsoft and Intel Combined by the way), Wal-Mart’s value has gone nowhere, mired around $185B. Wal-Mart’s answer is to buy back it’s shares.  The Board has authorized continuing and expanding a massive share buyback program of literally 1 million shares/day – 10% of all shares traded daily!  The amount allocated is 1/6th the entire market cap! At this rate 24x7WallStreet.com headlined “Wal-Mart’s Buyback Plan Grows & Grows.. Could Take Itself Private by 2025.” 

Share buybacks produce NO VALUE.  They don’t produce any revenue, or profit.  All they do is take company cash, and spend it to buy company shares.  The asset (cash) is spent (removed) in the process of buying shares, which are then removed from the company’s equity.  The company actually gets smaller, because it has less assets and less equity. (Compared to LInked-In, for example, that grew larger by selling shares and increasing its cash assets.)  Over time the cash disappears, and the equity disappears.  Eventually, you have no company left!  Stock buybacks are an end of lifecycle investment, and should trigger great fear in investors as they demonstrate management has lost the ability to identify high-yield growth opportunities.

Wal-Mart is steeped in assets. It has land, buildings, stores, shelves, warehouses, trucks, huge computer systems.  But these assets simply don’t produce a lot of profit, as competitors are squeezing margins every year.  And there’s not much growth, because doing more of what it always did isn’t really wanted by a lot more people.  So it has gobs of assets.  So what?  The assets simply aren’t worth a lot when the market doesn’t need any more retail stores; especially boring ones with limited product selection, limited imagination and nothing but “low price.” 

Assets aren’t the “store of value” analysts gave them in an industrial economy, and it’s time we realize investing in “assets” is fraught with risk.  Assets, like homes and autos have shown us, can go down in value even easier and faster than they can go up.  Global competitors can match the assets, and drive down prices using cheap labor and operating by less onerous standards. In today’s market, assets are as likely to be an anchor on value as an asset.

I started 2011 saying Apple was a screaming buy.  Today that’s even more true than it was then.  Apple’s revenues, profits and cash flow are up.  Sales in existing lines are still profitably growing at double (or triple) digit rates, and enhancements keep Apple in front of competitors.   Meanwhile Apple is entering new markets every quarter, with solutions meeting existing, unmet needs.  Because value has been stagnant, the value (price) to revenue, earnings and cash flow have all declined, making Apple cheaper than ever.  It’s time to invest based on looking to the future, and not the past.  Doing so means you buy Apple today, and start dumping asset intensive stocks like Wal-mart.

Update 12 June, 2011 – Chart from SeekingAlpha.com.  Apple’s cash hoard grows faster than its valuation.  When a company can grow cash flow and profits faster than revenues – and it’s doubling revenues – that’s a screaming buy!

Apple Cash as Percent of Share Price

 

Who “gets it”? – Employment, investing and IBM

"IBM authorizes another $5Billion for share buybacks" is the Marketwatch.com headline.  This brings the amount available for buying the stock to $9.2billion – or enough to buy about 73.6million shares.  But it begs the question, what value will this bring anyone?

"The U.S. Workplace: A Horror Story" is the CIOZone.com headline. A survey by Monster.com and The Human Capital Institute of more than 700 companies (over 5,000 workers) discovered that by and large, employees are mad at their employersThey don't trust business leaders, and think those leaders are exploiting the recession for their own purposes (and gains).  79% of workers would like to find a better employer – to switch – but only 20% of employers have a clue how many workers have become disillusioned.

Simultaneously, "Many vanished jobs might be gone for good" is the Courier-Journal.com headline.  Historically, increases in manufacturing (usually led by autos) and construction (primarily housing) caused recessions to diminish.  But nobody expects either of those sectors to do well any time soon.  Manufacturing is showing no signs of improving, in any sector, as we realize that all the outsourcing and offshoring has permanently reduced demand for American labor.  And quite simply, very few investments are being made by business leaders that will create any new jobs.

"ALL BUSINESS:  Innovation Needed Even in a Recession" is the Washington Post headline.  The article points out that almost all recent improvement in profitability – boosting the stock market – has been through cost cutting.  But that has done nothing to help companies improve revenues, or improve competitiveness It's done nothing to bring new solutions to market that will increase demand.  Quoting the former Intel CEO Gordon Moore – "you can't save your way out of a recession" – the article cites several consultants who point out that companies which earn superior rates of return use recessions to invest in new technologies and innovations that create new demand.  And eventually new jobs.  But today's CEOs aren't making those investments.  Instead, they are taking short-term actions that dress up the bottom line while doing nothing about the top line.

Which brings me back to IBM.  Who benefits from $9.2billion being spent by IBM on its own stock?  Only the top managers who have bonuses and options linked to the stock price.  The shareholders will benefit more if IBM invests in new products and services that will increase revenues and drive up long-term equity.  Employees and vendors will benefit from creating new solutions that generate demand for workers and components.  Almost nobody benefits from a stock buyback – except a small percentage of leaders that have most of their compensation tied to short-term stock price.

What new innovations and revenues could be developed if IBM put that $9.2billion to work (a) at its own R&D, product development labs or innovation centers, or (b) at some young companies with new ideas that desperately need capital in this market where no bank will make a loan, or (c) with vendors that have new product ideas that could meet shifting markets? 

That's the beauty of an open market system, it supposedly funnels resources to the highest rate of return opportunities.  But this doesn't work if managers only cut costs, then use the money to prop up stock prices short term.  It's a management admission of failure when it buys its own stock.  An admission that there is nothing management can find worth investing in, so it will use the money to artificially manipulate the short-term stock price.  For capitalism to work resources need to go to those new business opportunities that generate new sales.  Money needs to flow toward new health care products and new technologies – not toward keeping open money-losing auto companies and failed banks that won't make loans.

If we want to get out of this recession, we have to invest in new solutions that will increase demand.  We have to seek out innovations and fund them.  We cannot simply try to Defend & Extend Success Formulas that are demonstrating their inability to create more revenues and profits. Laid off workers do not buy more stuff.  We must put the money to work in White Space projects where we can learn what customers need, and fulfill that need. That in turn will generate jobs.  And only by investing in new opportunity development will workers begin to trust employers again.    IBM, and most of the other corporate leaders, need to "get it."