Bad news doesn’t go over well in a bear market — take retailer Walmart‘s (WMT 2.16%) recent announcement of reduced profit guidance for the rest of the year. Wall Street responded by selling off the stock to within reach of its lowest share price in a year.
But just because the market is bearish doesn’t mean you have to be. Here is why Walmart’s short-term challenges could prove to be a buying opportunity for investors.
What’s going on?
Walmart gave a recent business update, noting that it expects operating profits for Q2 to decline between 13% and 14% year-over-year and full-year operating profits to drop between 11% and 13% from the prior year.
Management previously communicated in February that full-year earnings-per-share (EPS) would grow by mid-single digits, but revised that down to negative 1% in May. Now, just a few months later, management’s saying EPS will fall 10% to 12% on a non-GAAP basis.
What’s the cause? Management has noted that high inflation hurts consumers, who are pulling back on discretionary purchases to afford necessities like food and gas. Groceries carry lower profit margins, and Walmart must now discount built-up inventory in categories like apparel. These factors combine to hurt the bottom line.
Why investors shouldn’t panic
Investors should understand some context of Walmart’s struggles before hitting the panic button. First, inflation in the U.S. is the highest in generations since the infamous 1970s. Additionally, you can see from the drastic swing in guidance in a short time that Walmart was caught off guard by the speed at which consumer spending is changing.
In other words, if you think Walmart’s struggles are bad, imagine what smaller competitors and those that purely sell discretionary products are facing. Remember, Walmart is the largest grocery store by sales in America; it will continue seeing customer traffic, which is why management expects sales growth of 5.5% this year.
Next, a business will probably face challenges if you wait long enough. You can see below that Walmart’s profits have plummeted twice in the past decade alone.
However, investors who bought shares in 2007 and held through the occasional turbulence are up 288%, outpacing the S&P 500.
Looking further out
Staying focused on the long term helps you avoid letting short-term distractions scare you away from a great business. Of course, Walmart may struggle this year and potentially next year if a recession extends that long.
However, don’t forget that Walmart’s been in business since the early 1960s, working through multiple economic ups and downs, and has paid and raised its dividend for 49 consecutive years.
History often rhymes, and you’ll see that Walmart’s been through this before, and at a time when it was a much younger, more fragile business than the behemoth today that does more than $570 billion in annual sales.
As you can see in the chart above, inflation will likely cool down again at some point, and these pressures currently squeezing Walmart’s profits will subside.
The company’s updated guidance indicates that full-year EPS will come in at around $5.81, meaning a forward price-to-earnings ratio of almost 21. This is higher than the stock’s median P/E of 17 over the last decade; however, remember that top-line growth is intact, and the inventory headaches squeezing profits should be temporary.
In other words, the stock wouldn’t be as expensive as it seems if not for unusual circumstances. Analysts still believe Walmart can grow EPS by 5% to 6% annually over the next three to five years.
Wall Street promises nothing. The shares could keep falling in the weeks and months ahead. However, Walmart is a Dividend Aristocrat and remains one of the world’s largest and most influential companies. These short-term bumps present a buying opportunity worth considering for long-term investors.