Course 209: Why Does a Stock's Price Rise or Fall?
Case Study in Rising Prices: Wal-Mart
In this course
1 Introduction
2 Case Study in Rising Prices: Wal-Mart
3 Falling Prices: The Internet and the Oil Industry
4 Looking at the Long Term

A stock's price is determined by its fundamentals (how the company has actually performed) combined with its valuation (how much the market is willing to pay for that performance and the promise of future growth). Similarly, when a stock's price goes up, that rise comes from either (1) growth in the underlying business or (2) an increase in the stock's valuation, as the market becomes more optimistic about the company's future. As an illustration of these two drivers of stock performance, consider the history of Wal-Mart WMT. In the 1970s and 1980s, Wal-Mart was the quintessential growth stock. It was profitable, with returns on equity consistently above 20%. Year after year, its revenue and earnings grew by more than 25%, often by more than 30%, as it opened new stores all over the country. As a result of this consistent growth, the annualized return of Wal-Mart's stock from 1970 to 1990 was about 35%. That's an impressive figure, but most of this return came from solid growth in revenue and earnings; Wal-Mart's valuations increased only modestly during this time. In the early 1990s, this growth began to slow as the retailing giant started running out of places to expand in the United States. The number of new Wal-Mart stores barely inched up in 1994, after routinely increasing by 10% annually, and the following year the company's revenue growth dropped to less than 20% for the first time ever. Suddenly, it began to look as though Wal-Mart had saturated the market, and its days as a growth juggernaut seemed to be over. The company's earnings continued to grow, albeit at a more modest rate of 10% to 15% annually, but its valuation eroded at about the same rate as the market lost confidence in Wal-Mart's future. As a result, its formerly robust stock stayed flat and actually lost a little ground between late 1991 and late 1996. From 1997 through 1999, Wal-Mart worked hard to turn itself around, improving profitability and trying to spur growth by expanding into new markets, particularly overseas. The market took notice of Wal-Mart's rejuvenation, propelling its stock to an 80% annualized return during those years. But this return, unlike those from the company's previous glory days, was fueled mostly by valuation. Wal-Mart's earnings grew 75% over that time, but its price/earnings ratio more than tripled, growing from 20 to 70. (Annualized, about 20% of that return came from earnings growth and 60% from valuation growth.) That valuation increase means that at the beginning of 2000, the market valued Wal-Mart's stock more on expectations of future growth than it had a few years earlier, no doubt enticed by the prospect of Wal-Mart becoming as ubiquitous in the rest of the world as it is in the U.S.

Next: Falling Prices: The Internet and the Oil Industry >>


Search
Print Lesson |Feedback
Del.icio.us Del.icio.us | Digg! digg it
Learn how to invest like a pro with Morningstar’s Investment Workbooks (John Wiley & Sons, 2004, 2005), available at online bookstores.
Copyright 2015 Morningstar, Inc. All rights reserved. Please read our Privacy Policy.
If you have questions or comments please contact Morningstar.