If we've learned anything from the past decade, it is that the stock market can be irrational and it can remain so for long periods of time. As an example, let's examine a company that just released quarterly earnings earlier this week: Wal-Mart . Wal-Mart's stock has essentially done nothing over the past decade despite posting impressive and consistent earnings growth over that time frame. The stock is an excellent example of market irrationality because we have seen both extremes: massive over-valuation during the bubble years followed by unjustified under-valuation today. Just as the company was irrationally trading at nearly 40x earnings on average back in 1999-2000, the company is now trading at an irrational discount to the market. Consider the following:
1) Wal-Mart has grown its earnings-per-share (EPS) every year for the past 15 years - through two recessions, including one of the worst in decades
2) The company's compound annual growth rate in EPS over the past 10 years has been 11% - well above the 2% for the S&P 500
3) Wal-Mart's guidance for 2010 EPS is over 3x the level reported for 1999, while S&P 500 earnings are expected to come in at just over 1.5x the 1999 level
4) Wal-Mart's dividend has risen every year over the past ten years and is up nearly 600% since 1999
Despite this impressive performance, WMT has gone from trading at a 50% premium to the S&P 500 in 1999-2000 to a discount, based on estimates for 2010 and 2011. What makes this more puzzling is that Wal-Mart is generally considered a defensive stock. During the most recent recession (which most believe ended some time last year), Wal-Mart benefited as consumers "traded down" to more affordable alternatives. As we look ahead to what appears to be another slow down in economic growth, we would expect investors to more highly appreciate the relative visibility of Wal-Mart's earnings stream. But instead, Wal-Mart continues to get no respect. We believe this creates an opportunity for longer-term investors.
Wal-Mart is just one example of many quality stocks that appear to be trading at attractive levels in an uncertain environment. In general, we continue to believe that high-quality, defensive multi-nationals with attractive dividend yields are not receiving their due consideration in this market. Why is this the case? We certainly have our theories. First, we believe that the proliferation of hedge funds has resulted in an increased emphasis on "high-beta" stocks. In an effort to improve returns, hedge fund managers pour money into these more volatile stocks in an effort to improve returns while the overall trend in stocks is higher. Given the massive increase in the market since the lows in March 2009, it should therefore come as no surprise that these relatively low-quality companies have outperformed.