Two Critical Lessons From the Wal-Mart (WMT) Plunge

It is one of the most powerful forces in today’s economy. We call it the “Wal-Mart Effect.”

If you watched the action from the behemoth retailer last week, you got a glimpse of what’s at stake for investors.

[ad#Google Adsense 336×280-IA]Most folks have no idea just how massive and influential Wal-Mart (NYSE: WMT) has become.

One stat tells the tale… Sam Walton’s Bentonville baby has grown to become the world’s third-largest employer.

Every two weeks, it cuts paychecks to some 2.2 million employees.

Only two organizations have more manpower… the Chinese Army and the American Department of Defense. (The iconic company literally has an army of door greeters.)

With so much influence, it’s no wonder that some of the smartest folks on Wall Street refer to the retailer as the “Arkansas Fed.” Its economic sway has grown nearly as strong as the monetary maestros at the Federal Reserve.

Because Wal-Mart surprised the Street last week with its news of a rather dismal outlook, it’s wise to take a deeper look at what’s happening. There are lessons to be learned.

After all, what affects Wal-Mart certainly affects America.

Seeing is believing…

The chart clearly shows Wal-Mart and the American economy (as measured by revenue and GDP growth) have grown into an incestuous relationship so tangled that it’s impossible to tell where one stops and the other starts.

Boiled down, it’s a bittersweet tale. A small-town businessman finds success… knocks on the door of mom and pops across the country… and eventually forces its ultra-thin margins on the rest of the planet.

But just as central banks across the world have learned money can only get so cheap, Wal-Mart has learned margins can only get so small. As the saying goes, it can’t “make up for losses on volume.”

Two things are the standout culprits for the company’s recent woes. We argue both have had a similar effect on the global economy.

First, shortly after taking the corner office, fresh Wal-Mart CEO Doug McMillan bowed to public and political pressure and promised to boost pay for thousands of the company’s hourly workers. Early next year, the minimum hourly wage of its American employees will rise to $10.

The plan has come with big costs… some $2.5 billion. And, last week, as the company told us to expect profits to drop by as much as 12% next year, it admits 75% of that fall comes thanks to increased wages.

It’s critical to note here that while Wal-Mart is pushing wages higher by double-digit percentages for thousands of workers, American wage growth has stagnated over the last half-decade.

In other words, because of growing political and populist pressure, Wal-Mart is one of few companies boosting pay. Clearly, it’s been painful.

Lesson No. 1 to investors… steer clear of politically driven investments. Let capitalism and the free markets do their job.

The only way Wal-Mart can realistically afford to raise wages is if it can puff some air back into its profit margin. Unfortunately, it’s gotten a nasty taste of its own medicine in recent years.

That idea leads us to another vital fact. Over the last three years, Wal-Mart’s revenue has barely budged. It’s up by less than 10%. Meanwhile, its stiffest online competitor, Amazon.com (Nasdaq: AMZN), has watched its sales nearly double.

It’s this ballooning pressure from the e-commerce realm that virtually ensures Wal-Mart’s margins won’t rise anytime soon. With so much online sales competition, it can’t afford to boost its prices.

After having the decades-long luxury of outpricing its mom-and-pop competitors, Wal-Mart is now getting beat by low-priced online competitors that offer much more convenient shopping.

In other words, the “Wal-Mart Effect” has now become a detriment to the company, which leads us to Lesson No. 2 to investors… don’t blindly trust competitive barriers to last forever. Time and technology always win.

Wal-Mart’s effect on the economy is powerful. It’s one of the leading reasons the recovery of the last few years has seemed so disjointed. And it’s one of the reasons inflation has all but disappeared from our economy.

In fact, we argue it’s the spread of the “Wal-Mart Effect” that has flat-out stifled the Fed’s ability to stir inflation. It has done to pricing power what the Nina, Pinta and Santa Maria did to global trade some 520 years ago.

It’s not a bad thing… it’s the free market at work.

It’s only dangerous if you ignore it. After all, the heirs to the Wal-Mart fortune lost $11 billion in combined net worth on Wednesday – all because they failed to heed the two simple yet critical ideas above.

Make no mistake, the “Wal-Mart Effect” is reshaping the global economy. Understand what’s truly happening and you’ll see a world of opportunity within these trends.

Good investing,

Andrew

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Source: Investment U