An investment advisor at a prominent brokerage firm is evaluating whether to advise her clients, who currently do not hold Wal-Mart stock among their portfolios. This case study introduces fundamental valuation concepts, which includes dividend discount model, price-earnings model, and the application of the capital asset pricing model. It also looks into the reasonable valuation range for Wal-Mart stock.

â€‹Stephen R. Foerster

Harvard Business Review (906N09-PDF-ENG)

September 23, 2009

### Case questions answered:

- Evaluate the financial status of Wal-Mart based on an analysis of the Financial Statements. How is Wal-Mart’s current performance? (Help: Use financial indicators, remember that an indicator alone does not say anything. Recommendation: compare with indicators of comparable companies and sector/average of comparable companies).
- Determine a range, maximum and minimum value in which Wal-Mart’s intrinsic value should be contained (on a per share basis) using the P/E (Price-Earnings) approach. As part of your analysis you will have to determine an adequate prospective P/E multiple, taking into account competing companies, which is why you must justify your selection. Be clear with the assumptions you make.
- Determine the intrinsic value of Wal-Mart (on a per share basis) using the discounted dividend model (DDM). Evaluate the value of the stock based on three forms of the DDM: the constant growth version, an evaluation based on three years of projected dividends and a projection of the share price, and the three-stage discounted dividend model. Be clear with the assumptions you make including the estimate of Wal-Mart’s investor return that is required.
- Based on your analysis, like Rachel Martin, what recommendation would you make? Justify your recommendation and conclude about the different models used. What is the reasonable valuation range for Wal-Mart stock?

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## Valuing Wal-Mart Stock Case Answers

This case solution includes an Excel file with calculations.

#### 1.) Evaluate the financial status of Wal-Mart based on an analysis of the Financial Statements. How is Wal-Mart’s current performance? (Help: Use financial indicators, remember that an indicator alone does not say anything. Recommendation: compare with indicators of comparable companies and sector/average of comparable companies).

Based on Wal-Mart’s liquidity, activity, debt and profitability indicators, making a comparison with its different main competitors, Wal-Mart’s current performance can be evaluated, thus achieving a better understanding of its operations based on an analysis of its financial statements.

The liquidity indicators used were the current ratio and the acid test, since these allow us to analyze the ability of a company to meet its short-term obligations and help us understand their ability to pay. The current ratio is calculated by dividing the current asset by the current liability:Â Current Ratio = Current Asset/Current Liability. Active current minus inventory by passive current: Acid Test = (Active Current – Inventory)/Passive Current. Usually we look for these two indicators to be greater than 1 and the higher they are means that the company has greater capacity.

The activity indicators used were CxC Turnover (Days), CxP Turnover (Days) and Inventory Turnover (Days), since these allow us to evaluate the ability of a company to manage its accounts receivable, its accounts payable and its inventories. The turnover of accounts receivable (CxCDdays) is a vital financial indicator that measures the efficiency with which a company recovers the money your clients owe you.

To calculate the CXCDays, the following formula is used:

CxCDias=Accounts Receivable*360 /Sales.

The turnover of accounts payable days (CxPDdays) is a financial indicator that measures the efficiency with which a company pays its debts to its suppliers.

To calculate the CxPDdays, the following formula is used:

CxPDays = Accounts Payable * 360 / Cost of Sales.

Inventory Turnover in Days is a vital financial indicator that measures the efficiency with which a company sells and replenishes its inventory. To calculate Inventory Turnover in Days, the following formula is used:

Inventory Turnover in Days = Inventories * 360 / Cost of Sales.

The debt indicators used were Debt Level, Accounting D/E Ratio and Financial Leverage. These indicators are mainly used to analyze the solvency of a company in the long term. The debt level helps visualize the weight that the total liabilities have on the financing of the assets, this is calculated as NE = Total Liabilities/Total Assets.

The D/E ratio is used to compare financing solely from creditors in relation to the resources of shareholders and is calculated as D/E = Long-Term Debt/Equity. Finally, financial leverage is used to compare creditors’ financing relative to shareholders’ resources and is calculated as Leverage = Total Liabilities/Equity.

The profitability indicators used were gross margin, EBIT margin, and Net margin. These indicators were selected because they reflect the percentage left in each of the profits.

The gross margin is a fundamental financial indicator that measures the profitability of a company after deducting the direct costs of production or acquisition of its products or services. This is calculated as Gross Margin = Gross Profit/Sales.

EBIT Margin is a key financial indicator that measures the profitability of a company before deducting interest and taxes, it is calculated as EBIT Margin = EBIT/Sales.

Net Margin is a key financial indicator that measures the profitability of a company after deducting all costs and expenses, including the costs of production, administration, sales, marketing, interest and tax. s, it is calculated as Net Margin = Net Profit / Sales.

Analyzing Wal-Mart’s financial indicators against its main competitors shows that…

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MBA student, Boston