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- Allow WMT to consolidate after breakout of 13 year trading channel; accumulate shares under $70 for long term hold.
– Short-term traders consider bullish option spreads at support

You may be forgiven for thinking that a full scale bribery scandal in Mexico uncovered by the New York Times last April might at least temporarily derail the stock performance of most wholesome, all-American Dow components. And in the case of Wal-Mart, you would be right, if your definition of “temporarily” is about 3 trading days. After the story broke over the weekend of April 21, WMT gave up about $5 over the subsequent 19.5 trading hours. Since that time, however, Wal-Mart has staged a rather remarkable rally, adding over 25% to its stock value. What makes this recent surge all the more noteworthy is the disobliging nature of the other 29 stocks in the Dow: the index fell -1.6% over the same period. But the real reason to sit up and take note is the 10 yr chart on WMT. Since 1999, WMT’s stock has essentially been a textbook example of going nowhere. That’s nearly 13 years of treading water, providing little in the way of performance other than through dividends. So the fact that the stock decides to finally buck the trend in this environment, in the aftermath of a supposed scandal, is reason to take a closer look.

Wal-Mart shareholders recently received notice of a class action lawsuit – called a shareholder derivative suit – initiated by CalSTRS (the California State Teachers’ Retirement System) and stipulating that Wal-Mart executives needed to make amends for the injuries suffered as a consequence of the scandal and the immediate decline in the stock price. It is hard to imagine how well arguments from plaintiff’s counsel will fare when the stock now sits in the $71-73 range, well above where the stock sat before the scandal, well above where the stock has traded for the last 12 months, well above where the stock has been…..ever. If this kind of performance counts as injury to shareholders, most WMT investors are likely hoping that the healing be neglected.

The Real Culprit

Alright, so perhaps it wasn’t quite the bribery scandal that has jumpstarted WMT’s shares lately. More likely it was their quarterly earnings released in the middle of May. Wal-Mart announced earnings of $1.09 per share and revenue of $112.3 B (compared to $0.98 and $103.4 B in the same quarter of last year), beating consensus estimates and Wal-Mart’s own guidance. Following the release, shares increased 8 straight days in a row and have continued to climb since then to their short term resistance of $73 (see below). While the bribery scandal involving Walmex, Wal-Mart’s Mexican division, is still a potential overhang on the stock, the issue at this juncture appears academic to investors as they have had no qualms about pushing the stock to all time highs. Since this is not exactly the first time WMT has bested Wall Street estimates, what demands attention is the recent breakout and what it might mean for future growth.

Recent History

A look at WMT’s chart going back to 1999 makes clear that being a long term shareholder would have been an exercise in patience, mediating between highs that flirted briefly above $60 and lows that bounced reliably off of the $43 level.

WMT 13 year chart

Wal-Mart (WMT) 1999-2012: Chart Courtesy of MetaStock

During this time, WMT has continued to grow EPS by nearly 12% per year and revenues by 7.5%. What then accounts for the flat-line stock performance? Simply put it is the result of multiple contraction. Since 1999, its P/E ratio has fallen from well over 40x in the heady days of the equity bubble, to 30x in 2003, to the upper teens during the trough of the 08-09 crisis, to around 12x during most of 2011. This was the lowest multiple WMT had seen in over 20 years. Despite that fact that even during the 2007-2009 period, a nightmarish time for retailers everywhere, WMT’s earnings growth never turned negative, a falling P/E ratio means that a stagnant stock price will be the likely result.

After this Move, When Do You Buy?

Having broken free of its decade long sleepwalk, could the stock of the world’s number 1 retailer get energetic again? WMT’s recent price revealed that, once roused, it could move and move resolutely. With a backdrop of European worries and slowing US and emerging market growth, WMT has proven resilient and hints that investor psychology has fundamentally shifted on the stock. Perhaps in this age of seeking cover in defensive names precisely for the problems just listed, WMT may be just what investors need. Operating over 8700 outlets in 15 countries with a market cap of $243 B and a dividend yield of 2.2% provides the stability and predictable income the times call for. And when markets seem to oscillate between the opposing themes of Treasuries (when fearing slowdowns, recessions, and deflation) or gold (when uneasy about quantitative easing and inflation), WMT may provide the right prescription for navigating between the possibility of either scenario.

But has WMT moved too far to justify entering the stock now? In the short term, probably. But this breakout from such a protracted range is significant and merits that WMT be monitored closely for entry points. Over the last 10 trading days, WMT has encountered short term resistance at $73, indicating the possibility that it may take a breather and pull back from that level.

WMT 10 day chart

Wal-Mart (WMT) 10-day: Chart Courtesy of MetaStock

With temporary weakness, long term investors may capture long-awaited gains at this point. But given its resilience to the diffuse bearishness of the market and its ideal standing as a defensive stock, pullbacks may be brief. If you decide to keep some powder dry for WMT, drops beneath $70 should be occasion to load the musket. More serious declines down to the mid $60s would still be buying opportunities since those levels are above the long term resistance of $62-63.

WMT 9 month chart

Wal-Mart (WMT): Chart Courtesy of MetaStock

A Few Option Alternatives

If you think that WMT may return to its old ways and simply find a new trading range here with $63 as the new floor, you may want to look at entering a bear call spread for the short term since the stock in this scenario is sitting at the upper end of its range. Think of this strategy as similar to selling calls but with the protection of buying a further OTM strike price in place of owning the stock.

Example (prices as of 7/23):

Sell Sep 72.50 calls for $1.40 (near short term resistance)
Buy Sep 75 calls for $0.58
Credit of $0.82; total risk of $1.68 (2.50 difference in strike prices less credit from the spread)

As a complement to this strategy, if and when WMT declines to the lower end of its range, a bull put spread would be ideal. Again, this is similar to selling puts since you are bullish on a move back into the range. You are buying a further OTM strike to avoid having to buy the stock outright if it declines too far. Credits offered on this strategy will be more favorable if the stock retests its previous resistance near $63.

However, if you like the potential of WMT for the long term, you may consider buying slightly ITM calls with longer expirations. The March 2013 70 calls are currently $4.70, making your breakeven point $2.85 above the 7/23 close. Any break through the $73 resistance in the next two to three months would confer solid returns on these calls.

Chart courtesy Finviz. Click to open in larger window.

This is not investment advice. Learning Markets, LLC is not responsible for errors or omissions. Please be sure to read our disclaimer.