Selling Growth Away
In our March 25, 2009 blog, we mentioned Gap Inc. as an example of overpaying and thereby selling away future growth. We discussed the “Greater Fool Theory” where investors (or rather, speculators) adhere to the belief that there will always be someone stupider than them by paying an even higher price. We felt that today, an appropriate “April Fools” discussion would be to revisit this greater fool concept by taking a look at Wal-Mart. Despite high earnings per share growth, unfortunately, shareholders who held this stock over the prior decade haven’t experienced the same type of returns.
To avoid any effects of the recent chaos, let’s look at the company’s operating results from 1999 to 2007. Using Valueline figures, revenue/share and earnings/share grew at an annual compound rate of 12.4% and 12.0%, respectively. Not bad for a behemoth of a company. Looking at these numbers, one would think an investor would have made a fantastic return. But despite eight years of fabulous operating results, the stock has hardly budged. For most of 1999, Wal-Mart traded in the $40-50 range. At its peak, the stock actually traded above $70/share. In 2007, eight to nine years later, the stock was trading in the same $40-50 range! Depending when you purchased in 1999, including dividend reinvestment, an investment in Wal-Mart would have compounded at an annual rate anywhere from -4.3% to 2.1%. Inflation grew at 2.6% over that same time frame. In other words, no matter when you bought in 1999, you still would have had a permanent loss of capital relative to inflation.
Why would anyone have paid 30-55 times earnings in 1999? Clearly, investors were expecting better growth results. Perhaps, they thought the future decade of growth would look similar to the prior decade. This is precisely why we are cautious about the price we pay for a stock. We prefer to purchase a company with a high cash yield, rather than pay a high price and bank on having your returns come from unpredictable growth that may never pan out. Once again, another great example of purchasing a great business at a high price will turn out to be a poor investment.
Disclaimer: The specific securities identified and discussed should not be considered a recommendation to purchase or sell any particular security. Rather, this commentary is presented solely for the purpose of illustrating YCG’s investment approach. These commentaries contain our views and opinions at the time such commentaries were written and are subject to change thereafter. The securities discussed do not represent an account’s entire portfolio and in the aggregate may represent only a small percentage of an account’s portfolio holdings. These commentaries may include “forward looking statements” which may or may not be accurate in the long-term. It should not be assumed that any of the securities transactions or holdings discussed were or will prove to be profitable. Past performance is no guarantee of future results.