Why Warren wants Walmart

why-warren-wants-walmartWarren Buffett is doubling up on Wal-Mart Stores Inc. (WMT) stock. Why does Warren want Walmart? Obviously, he thinks the price will go up from the $49.81 at which I estimate he bought the shares. But the stock is not cheap -- unless Warren has a better yardstick for measuring Walmart's future earnings growth.

How much Walmart stock does Buffett own? CNNMoney reports that his investing company, Berkshire Hathaway (BRK.A), boosted its stake by 90% from 19.9 million in the second quarter to 37.8 million shares in the third quarter. I don't know precisely what price he paid for the 17.9 million additional shares he bought , but Walmart's stock ranged between $47.73 and $51.88 in the third quarter, so let's guess his average cost was halfway in between: $49.81.

What will Buffett get in the future for the $892 million I estimate he spent on those new shares? He obviously thinks the answer is much more money. But its short-term earnings forecast suggests that Walmart is trading at an expensive price/earnings to growth (PEG) ratio of 1.46. (Under 1 is cheap.) How so? I estimate a trailing P/E of 13.84 ($49.81/$3.60) on earnings forecast to grow at 9.5% to $3.95 in the year ending January 2011.

Buffett is smarter and richer than I am, so he must have a different earnings forecast. If my math is correct, he would need Walmart to post about 15% annual earnings growth -- possibly over the next five years -- for his purchase price to be cheap. That's because 15% earnings growth would make a P/E of 13.84 look cheap -- yielding a PEG ratio of 0.92.

What could possibly yield such rapid earnings growth? Reuters reports that Walmart did raise its January 2011 earnings from continuing operations guidance by a few pennies a share last week -- from between $3.50 to $3.60 to a range of $3.57 to $3.61 -- but that wouldn't get Walmart that much additional growth.

Going Bigger (and Smaller) Internationally

The answer may come from Buffett's hopes about faster growth internationally. For example, triplepundit reports that Walmart has aggressive plans to grow globally with smaller stores, which could be more profitable. For example, it wants to add 38 million square feet globally in the next year -- 14% less space than it added in the last year. Walmart plans to increase global square footage by about 37 million square feet in fiscal year 2011. But those future stores will each be eight percent smaller, and cost 16 percent less to build, than the chain's current stores.

Walmart also expects to get a higher return on investment from its supercenters -- adding 15 new Sam's Club stores in fiscal 2010, and between five and 10 new more in fiscal year 2011, according to triplepundit. And Walmart anticipates big growth internationally in growing markets such as China and Brazil -- adding 23 million square feet in fiscal year 2010 in its international stores, and about 25 million square feet in fiscal year 2011.

But unless Buffett knows better than Wall Street analysts how all this growth will accelerate profits from 9% to 15%, I am not sure how he expects Walmart shares to grow in value. They are trading 23% below their all-time high of $68.50 reached in January 2000. For the shares to climb anywhere near that level again, there must be something coming that I can't see -- but that Buffett can. I guess that's why he's the world's second-richest person.

Peter Cohan is a management consultant, Babson professor and author of nine books, includingCapital Rising (due in June 2010). Follow him on Twitter. He has no financial interest in the securities mentioned.

Read Full Story