Hannibal Lecter Analyzes Wal-Mart (Part 2)

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The prior post asked you to guess the name and price that you would pay for this case study: http://wp.me/p2OaYY-2np (Part 1)

It is WALMART  Annual:1974-annual-report-for-walmart-stores-inc. If you had paid the HIGHEST possible market price in 1974 or the first quarter of 1975 (after reading this annual report),  you would have about 1, 300 times your money over 40 years not including annual dividends which today stand at about 31 times what you paid in the market (WMT 2014) through and despite wars, high inflation, double-digit interest rates, civil unrest, political changes and a mundane, extremely competitive industry, AND WMT’s stock price “UNDER-performing” the general stock market one-third of the time. See Wal-Mart 50 Year Chart_SRC.

Eat your heart out Buffett, Munger, Peter Lynch, and all other investing pantheons. The point is you would have made a lifetime fortune sitting on your hands for more than a third of a century. WMT is the pinnacle of an investment–a relentless compounding machine.  Buffett said the goal of an investor is to put together a portfolio of compounding machines.

Well, Wal-Mart was the king of compounders; a company that could generate high returns on capital AND reinvest those high returns into similar high returns.  As many of you know, it is easy to spot a company with high ROIC or ROE but how do you know if the company can grow and reinvest those high returns at the same high rates? If not, then that company should return the excess capital which it can’t reinvest to you through dividends or appropriate (below intrinsic value) stock buy-backs.

You could have paid any price in 1974, 1975, 1976, 1977, 1978, 1979 and generated over-15% annual returns.  How would you know that WMT would keep growing with such high returns? What could you have KNOWN? What can we use for tomorrow’s investments?

AT Hindsight Capital (my firm) we always pick the Wal-Marts.

Joking aside, what is the point of this case study and what are the lessons we can use?  Let’s be realistic, we may never find another “Wal-Mart” but at least we can study “perfection” or the best to grasp what principles to look for in a company and an investment. You could do worse than spend weeks or months studying the history of Wal-Mart. Start here Walmart.com/annual-reports and go to here: WalMart_AR. And read: Sam-Walton-Made-America.

What’s the point of viewing one of THE best?

Hockey Player http://youtu.be/gpDdaC1_UGg

NY Giants Lawrence Taylor on the loose: http://youtu.be/puV3z9_gb9g?t=2m56s

Playing the Piano: http://youtu.be/R-JjzU1ZwXE

You gotta at least see and hear excellence to know it.

Let’s get back to Wal-Mart. What is the essence–the key–to its ability to grow profitably for so long? What can you spot in the 1974 annual report that would have alerted you to its competitive advantage? In other words, follow Hannibal Lecter’s tutelage when analzing any investment: What is its nature? http://youtu.be/f33ieCWRWlI.

Here are two hints:

Sam Walton‘s passions included flying his own plane over the American countryside, hunting with his dogs, and sharing his good fortune with his family. But Walton will always be best remembered for his lifelong passion for providing low prices and good service to customers at Wal-Mart, his chain of discount stores that revolutionized the retail industry.

Walton did not invent the discount store when he opened his first store in 1962. But he did do something new. Wal-Mart introduced the concept of selling a large number of items at cheap prices to residents of rural towns—customers other discount retailers ignored. From that base, Walton expanded Wal-Mart across the United States and eventually reached into foreign markets, using the latest technology to keep costs low.

“I think I overcame every single one of my shortcomings by the sheer passion I brought to my work.… If you love your work, you’ll be out there every day trying to do it the best you possibly can.” Read more: Walton

The second hint is that you will not see the financial results of WMT’s competitive advantage in its GROSS margins but in its NET margins. WHY?

The answer to my questions can be found in Competition Demystified (Chapter 5) but don’t cheat yourself. Think it through. In fact, if YOU wanted to get a job at hedge fund, investment firm or even work for a major service firm, you could do a comprehensive study of Wal-Mart’s rise and semi-fall of its competitive advantage and then find a new company or industry (Auto-parts?) where the same factors are at work.  Show what you can do while providing a study of value.  You will stand out from all the Harvard and Columbia MBAs.

I will post in Part 3: Analysis on WMT next week. Meanwhile focus on what is important.

How Markets Work (Trading Places) http://youtu.be/1tmI867fAYU?t=59s


7 responses to “Hannibal Lecter Analyzes Wal-Mart (Part 2)

  1. Pingback: Walmart: Competitive Advantage & Its Nature (Part 1) | Hurricane Capital

  2. Vishnu V Pillai

    Wow! Thanks for the insightful analysis.

    However, again we are using hindsight to pronounce that WMT was an obvious winner.

    One of my iron rules in investing is that the best investments always look like a bit of a fraud!

    Even Sam Walton admits that most people ignored him as an hill billy and a fly by night operator.

    Most investors now attribute the moat of retail as “baby shark” model or the current assets vs current liabilities gap- but note that WMT for most of its time had a ratio of > 1.5.

    The most important question is: if Walmart have cracked the puzzle why can’t it repeat else where? or why not others with same success?

    I think there is more to WMT than just an analysis of numbers will reveal.

    PS: I am big fan of Sam Walton. So I might be partial in supporting him.

  3. Vishnu V Pillai

    Serving as a Devils Advocate:


    Even as I think the best days of WMT are yet to come, which only a 21st century Indian stuck with 18th century stores will appreciate.

  4. Pillai: Thanks for the posts. Your article reinforces the regional economies of scale concept which WMT lacks in India, Germany, etc. relative to competitors. WMT expanded like an Amoeba on the fringes of its central, southwest locations serving areas that were overlooked and underserved by the big guys.

    You can use the concept of regional economies of scale in your investments. Do you want a service business like garbage hauling, medical services, and banking expanding willy-nilly or leveraging its SG&A. Coors, the beer maker, is a classic example of a company that didn’t know it had a regional advantage.

    Yes, finding the next Wal-Mart won’t be easy, but you have to start with an idea of structural competitive advantages and an owner-oriented entrepreneur.

    Good luck,

  5. Mr.Chew, Thank You for the reply.

    I have always wondered- It is easy to ignore WMT in its initial days, but why did no body cared about Southwest and Central?

    Most probably, it may be because the population and markets else where seemed more urgent to be addressed. So if Kmart were right, USA would have had a few regional retail chains, WMT would dominate its positions in Southwest and Central but unable to expand and Kmart and co. would burn few dollars competing with WMT at Sothwest and eventually settle strong where ever they were as formidable as WMT.

    But we know it didn’t.

    An analysis (at least with hindsight is possible if we get Annual Reports of Kmart and Target etc). If you have any links/ reports kindly share with us.

    Your point of leveraging regional dominance is a good point to be noted.

    Meanwhile, I would like to thank your excellent case study of Henry Singleton. Marvelous.

    • The trap with the WMT case study is hindsight bias and false positives. the number of quality franchises in the world–companies that have compounded their value at 20% over 15 to 20 years is probably less than 1% – 2% of all companies. So 99% of the companies you look at will not be emerging successful franchises. Needle in the haystack. But look at the causes of success and failures then apply to new situations. Be entrepreneurial in your search strategies.

      I look for lopsided bets always with my eye out for compounders but it is a bit like the search for the Holy Grail.

      Google annual reports (Target) go there.

  6. I totally agree.

    Regarding annual reports of Target- the site hosts only annual reports from 2005- which I guess is as they started off as a subsidiary of Dayton and same with Kmart (which was under SSK).

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