4.9 Business Strategy: Predictions

The strategies and some simple economics lead to predictions about business ratios.  For example, we would expect that in a recession some Target customers will shift to low prices away from "shopping experience" and higher prices.  In an expansion customers may be prepared to pay a little more for "shopping experience."  So we expect relative differences to be exhibited by the business ratios for these two stocks:

·         First, we predict that the profit margins for Target to be relatively higher and asset turnover for Wal-Mart to be relatively higher. 

·         Second, we predict that Target is more sensitive to the business cycle than Wal-Mart.  In particular, we expect that Target’s sales and profit margins are relatively more sensitive to economic downturns and upturns than Wal-Mart.

·         Third, we predict that Target’s ratios will be more volatile than Wal-Mart because of their greater sensitivity to the economy.

Of course, strategy is not fixed but can change over time.  For example, quoting from Wikipedia, “In March 2006, Walmart sought to appeal to a more affluent demographic. The company launched a new Supercenter concept in Plano, Texas, intended to compete against stores seen as more upscale and appealing, such as Target… The new store has wood floors, wider aisles, a sushi bar, a coffee/sandwich shop with free Wi-Fi Internet access, and more expensive beers, wines, electronics, and other goods. The exterior has a hunter green background behind the Walmart letters, similar to Neighborhood Market by Walmarts, instead of the blue previously used at its supercenters.” 

The following table contains the DuPont decomposition for the two companies.  The Year column refers to the 10-K year so the financials are for the year ending Dec 31 of the previous year.

From the table it is clear that overall Wal-Mart is outperforming Target in terms of both ROE and ROA.  The first two components of the DuPont decomposition identify the two major drivers of ROA, Profit Margin and Asset Turnover. 

First, as predicted, Target’s profit margins are higher than Wal-Mart’s.  Second, as predicted, Target has a lower Asset Turnover than Wal-Mart.  The product of these two terms is the ROA.  So even though Wal-Mart has a stronger ROE and ROA, Target has the advantage in profit margins and asset turnover over Wal-Mart, as predicted by differences in their business strategy.