TOPIC: Financial Statements, Stock Valuation, and Agency Costs

SOURCE: "Falling Profit Marks End of Era at Wal-Mart," by Kevin Helliker and Bob Ortega, Wall Street Journal, January 18, 1996, B1.

SYNOPSIS: Wal-Mart came very close to joining a select group of firms to report 100 quarters of consecutive earnings growth. However, sluggish sales in the entire retail sector and severe weather conditions in early January have led the firm to estimate a decline in fourth quarter EPS. The article illustrates the strong cause and effect relationship between a decline in the earnings growth rate and a decline in stock price. This sensitivity of prices to growth is underscored by the fact that Wal-Mart's quarterly EPS is expected to be between $0.40 and $0.42 per share, 4 to 6 cents below analysts' estimates. In fact, the firm's annual EPS is expected to rise materially. Finally, the article discusses Wal-Mart's use of stock incentives for all employees and the effect of the stock's sluggish performance on the effectiveness of this method of compensation.

DISCUSSION QUESTIONS:

1. What is "Earnings per Share," or EPS? What are the reasons for Wal-Mart's inability to continue their long history of EPS growth in the quarter about to conclude? Why might a casual reader of the graphs in the article assume that the situation is more dire than it really is?

2. How does Wal-Mart compensate its employees? Discuss the pros and cons of this compensation strategy.

3. If we view the value of Wal-Mart common stock as the present value of future dividends, explain how this news is likely to influence stock value. As a specific example, consider a stock where investors require an 18% return on their investment. If the current dividend is $0.20 per share but is expected to grow by 17% next year and by the same rate for the long term, use the constant growth model to determine value. Recompute this value if the growth rate is reduced to 16.5%. (Note: Similar to this example, Wal-Mart is a low-dividend, high-growth stock.)

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