Peter Lynch, in Beating the Street, talks about walking through stores or talking to family and friends in order to get to know the businesses better. So in the same spirit, I visited the 3 Wal-Mart’s and 3 Target stores, all within 20 minutes of my house. I talked to my wife and colleagues to get a feel for their likes and dislikes of these two retailers. The anecdotal evidence of that experience leads me to conclude the following:
1. People love to hate Walmart. Talk about Walmart and you ramp up emotions….strong emotions. It doesn’t take long to find people referring to Walmart’s “slave labor”, without considering that the over 2 million U.S. employees actually applied and accepted the work freely. Further, a web search revealed that Target’s employees (cashier) actually earn less or nearly the same and yet you don’t hear the same type of rhetoric regarding Target’s employees nor do you hear about the local city councils that don’t want the Target in their city.
2. One unanimous comment was that they preferred shopping at Target because it was less crowded. As an investor this does not please me. I want to see the large crowds. Each Target store I visited did not have nearly the type of traffic that the Walmart’s were attracting. This is confirmed by inventory turnover numbers.
3. Walmart has lower prices. This was also unanimous. Target may have some items cheaper, but they couldn’t match Walmart. This is confirmed by many studies, one recently indicating that Walmart was cheaper on 15 out of 20 items.
4. Walmart stores are uglier than Target stores, but not by a lot. Target stores are definitely more pleasing on the inside.
Without replicating the metric studies which are already available (and some are very good), I will go ahead and simply give you my 1 biggest reason for choosing Walmart over Target. This choice is predicated on the presumption that I only have a limited amount of funds which requires me to choose between the two. Reasonable people will always disagree, but it was an easy choice for me. I will confess that I had a harder time trying to determine whether to put a hyphen in “Wal-mart” or “Walmart”. I am admittedly perplexed by those that truly believe that Target will supplant Walmart someday.
Just to get a perspective as to the magnitude of Walmart, consider market capitalization:
HOME DEPOT (HD)
J.C. PENNEY (JCP)
Total: 172.55 billion
Warren Buffet coined the phrase “economic moat”, which describes a company with durable competitive advantage over its competitors. It is likened to a castle with a moat surrounding it, protecting it on a daily basis from predators seeking to conquer them. The wider the moat, the more protection provided to the castle. Walmart’s moat will not be compromised anytime soon. This is the reason I consider Walmart the best choice.
Being the low cost provider among the competition creates an economic moat. No company is in a position to try to take on Walmart head to head and this includes Target. I would suggest that if one of the two suddenly closed their doors, Target would find difficulty filling the need, whereas Walmart would fill the gap quite easily. This is one reason why Target’s moat, much narrower than Walmart’s, is what Morningstar’s Pat Dorsey refers to as “cheap chic”, dependent on choosing the correct fashions of the moment, but not the low cost provider. That metric alone makes Walmart the better choice.
Mary Buffett and David Clark, in “The New Buffettology”, state that “companies with a durable competitive advantage typically have long-term debt burdens of fewer than five times current net earnings.” Walmart passes this test. Target does not. Further, note the following debt ratios of the two:
Target: Long Term Debt/Equity 105.38, compared to Walmart’s 66.49
Target: Total Debt/Equity 111.10, compared to Walmart’s 86.17
Economic moats are typically gauged by three major metrics, however; arguments can be made for others. Let’s look at the three major criteria for determining the strength of an economic moat.
Return on Assets * Return on Equity * Return on Total Capital
Return on Assets is important for discount retailers because if you cannot raise prices easily, asset turnover will allow you to increase your profitability. ROA measures how efficiently you can turn assets into profits. Typically, you want to see a ROA minimum of 7% and consistently.
10 year average – 6.39
10 year average – 8.58
Asset Turnover – 1.47
Asset Turnover – 2.38
Return on Equity measure how well companies are generating good returns on the shareholders’ money. Once again, consistency is important and any number over 15% is considered exceptional and an indication of an economic moat. The higher the better.
10 year average – 16.3
10 year average – 19.9
Return on Total Capital is considered extremely important to the Buffett line of thinking according to “The New Buffettology”. Because price competitive companies can be financed with debt several times their equity, a high ROE may still be indicated, therefore; Buffett likes to go further by seeing a ROTC of at least 12%, along with the high (15% +) ROE.
10 year average – 8.7
10 year average – 13.2
The largest retail company in the world is the overall low cost provider to its customers and by its virtual size and numbers (metrics) cannot be matched by anyone soon with the economic moat it has created.