How Big Can It Get? Wal-Mart has been one of the top stocks of recent decades. Now, as the retail giant targets supermarkets, Europe and the Internet, investors are asking...
By Amy Feldman

(MONEY Magazine) – When you think of the great blue-chip growth stocks of the past quarter-century, what names come to mind? Coke? General Electric? Merck? Well, guess what. Wal-Mart has crushed them all. Since 1977, the stock has returned 35% annually, turning a hypothetical $10,000 investment into an astounding $6.9 million (see the chart on the opposite page). Going forward, it figures to outstrip most of today's crop of silicon start-ups and dotcoms--maybe all of them--over the long term.

Wal-Mart isn't in a sexy industry, isn't run by a young, entrepreneurial millionaire and doesn't woo Generation X-ers with promises of stock options. It's simply a juggernaut, built on a combination of cutting-edge technology--yes, it's a tech company--smiley-face service and good old-fashioned business skill. Wal-Mart has figured out how to pile up billions of dollars in profit by selling staggering quantities of low-margin goods. Its $147 billion in sales for the latest 12 months are double the sales of competitors Sears and K Mart combined, while its $4.9 billion profit in that period is nearly triple their total.

Relentless execution of its basic business model has helped Wal-Mart stock soar even while other retailers have been battered by fears of rising interest rates and declining consumer spending. At a recent $55, the shares are up 61% for the past 12 months. That's a tough pace to maintain, particularly in the cutthroat retail arena, where profit margins are slim, competition is tough, Internet start-ups are encroaching on traditional retailers' turf and many of the country's legendary stores have hit the wall. Can the Wal-Mart juggernaut keep going?

To answer that question, we spoke with Wal-Mart execs, Wall Street analysts, major shareholders, retail consultants, rivals and customers. We started in the small town of Bentonville, Ark., where Wal-Mart runs its far-flung operations from a converted warehouse building on Walton Boulevard. In a series of exclusive interviews, chairman Rob Walton (son of founder Sam), CEO David Glass and other top executives gave us a detailed picture of the company's strategy. They are planning growth on a mind-boggling scale for a company this big; their projections call for boosting both revenues and profits at least 15% a year (excluding any potential acquisitions). To hit those numbers--which would push sales past $200 billion in two years--Wal-Mart is steamrolling ahead on three main fronts: the grocery business, foreign markets and the Internet. We'll look at each in detail below.

Has Wal-Mart reached the point where it's just too big to keep growing rapidly? Perhaps. But the company's history is one of proving the naysayers wrong. "Our prospects are better today than at any point in our history," contends Glass. "We can be anything that we want to be. Any limits are self-imposed, because we can do whatever we want."


If that sounds more like an inspirational spiel from Tony Robbins than a dispassionate assessment of business prospects, that's simply the Wal-Mart way. At the shareholder meeting last June, more than 20,000 investors and employees descended on the local university's Bud Walton stadium for a morning of chatting and cheering ("Give me a W! Give me an A!...Who's No. 1? The customer!"). "It's like a cult," says Jerry Rascona, who runs the lawn-and-garden department in Wal-Mart's Middle Island, N.Y. store and owns some 700 shares of WMT stock. "We believe; therefore, it will happen."

Wal-Mart remains imbued with the spirit of Sam Walton, who died in 1992. Photos of Mr. Sam line the walls of the corporate headquarters, and the hokey customs he initiated, like cookie-stacking contests and "people greeters" at the stores' entrances, endure. But don't let the folksiness fool you. Like its founder, Wal-Mart is one big, tough, shrewd operator. It uses its size to wring the best deals from suppliers, and it carefully calibrates the price and placement of every item it sells, using reams of computer-generated data on the buying patterns of the 100 million people who come to its stores each week.


Indeed, Wal-Mart has shown how technology can revolutionize even the most mundane business. The backbone of the company's success is not the products or the stores but its 101-terabyte computer system, which Wal-Mart says is the second largest in the world, surpassed only by the Pentagon's. By analyzing the constantly updated information, Wal-Mart executives and store managers can track customer behavior with startling precision--and to great effect.

At Wal-Mart No. 0001 in Rogers, Ark., store manager Mike Walker points a hand-held scanner at a package of Kraft American cheese singles on special for $1.98. With the click of a button, the machine shows how many have been sold in the store that day and how many are in transit, in the warehouse and on order. Click again, and the handheld pulls up the price Wal-Mart paid for the cheese and tallies its profit margin. "We know everything about every item," Walker says. "We can get more sales and make more money based on what we know."

What are the bestsellers in each store by total dollars? By profits? By volume? Wal-Mart knows and can position its hottest items in the best locations for boosting sales. How well did a new product fare on its first day of introduction? Wal-Mart knows and can tweak the color or size or flavor of the product with the supplier immediately. Are golf balls flying out of one Florida store but languishing in another? Wal-Mart knows and can move the sluggish product to the place where it will sell, rather than having to mark it down.

What Wal-Mart is now learning to do with the data, however, goes beyond traditional inventory management. By looking into the shopping baskets of its customers, the chain is learning which items to stock near one another (bananas close to cereal, alarm clocks with suitcases). And by working closely with more than 7,000 vendors who have access over the Internet to the company's data on all of their products, Wal-Mart can hammer out deals for special flavors and sizes and instantly nix products that don't sell in early tests. By constantly learning what works and what doesn't, in real time, Wal-Mart can shift gears faster than many small merchants, let alone other giants. The payoff from all this number crunching: Wal-Mart has sliced its inventory costs (because goods sit on the shelves for less time) and increased its sales per square foot (to $374, vs. $222 for K Mart). "They make a lot of mistakes, but they are smart and very quick to react," says PaineWebber analyst Jeff Edelman. "That is what has enabled Wal-Mart to maintain that kind of momentum."


If you don't think of Wal-Mart as a grocery store yet, you will soon. Across the country, Wal-Mart is creating enormous 200,000-square-foot "supercenters" that offer all the usual items but also devote about a fifth of their floor space to groceries. Wal-Mart's foray into food will turn it into the country's No. 1 supermarket within five years, analysts predict, catapulting it ahead of Kroger and Safeway and pummeling many of the smaller chains.

Why would Wal-Mart move into a field with even lower margins, fiercer competition and more vexing distribution difficulties than the discount business? For starters, filling America's shopping carts is a $450-billion-a-year business, dwarfing the discount sector. And Wal-Mart executives see it as a field where the company's unparalleled skill at pushing large volumes of cheap goods will give it an unbeatable edge. People shop for food twice as often as for hard goods, so food brings more shoppers to Wal-Mart's supercenters, creating more potential buyers for the chain's higher-margin items, like books, CDs and computers. And tracking food purchases gives Wal-Mart information on its customers' ethnicity and demographics that it can't get any other way--letting it fine-tune its merchandising efforts even further. "Everything we do is a driver of volume," says Lee Scott, a 20-year Wal-Mart veteran who was tapped as chief operating officer early this year and is expected to become the next CEO. "Additional customers let us lower the price, and lower prices draw additional customers."

Moreover, Wal-Mart sees the food sector as ripe for conquest. It is extremely fragmented--with the top two chains, Kroger and Safeway, accounting for just 12% of sales last year--and in the throes of consolidation, with many smaller players declaring bankruptcy. While many of the country's grocers are preoccupied with the problems of integrating acquisitions, says Barrett Ladd, a retailing consultant at Management Ventures, Wal-Mart is simply rolling out new stores. (Wal-Mart prefers not to buy existing chains, because it wants to sell food and its traditional merchandise under one roof.) There are already 650 supercenters, and next year alone, Wal-Mart figures on adding at least 160 new ones, mostly by knocking down the walls of existing discount stores to create space for food.

At the same time, Wal-Mart is testing a new concept called the Neighborhood Market in a handful of locations in Arkansas. Dubbed "small-marts," these green-and-white stores are stocked with fresh fruits and vegetables, a drive-up pharmacy, a 24-hour photo shop and a selection of classic Wal-Mart hard goods. While Wal-Mart is moving slowly on this concept, planning to open no more than 10 next year, the goal is to ring its superstores with these smaller offshoots--keeping them close enough to be served by the same distribution centers--to attract customers who may be in a hurry or want only a few items.

But with nearly 3,000 Wal-Marts and membership-only Sam's Clubs, isn't the nation already saturated? Won't building so many new stores simply shuffle customers from one Wal-Mart to another? "We've been willing to cannibalize our stores rather than going into a defensive mode where we insist each store has to make a certain amount of profit," says COO Scott. His reasoning rests on the simple advantages of size: He figures that the overall increase in market share and corporate profitability more than offsets the negatives of cannibalization. The strategy seems to be working. "Wal-Mart's domestic business has tremendous momentum and continues to gain market share from weaker competitors," says Eileen Leary, retail analyst for State Street Research, a mutual fund firm with about 4 million Wal-Mart shares.


Most of Wal-Mart's growth over the next few years will come in the United States, but eventually Wal-Mart will run out of room here. Naturally, it has looked abroad for new turf. But it has made many costly mistakes since it first ventured out of the U.S. eight years ago with a store in Mexico City. Time after time it sold the wrong products (tennis balls that wouldn't bounce in high-altitude Mexico City, for example, and 110-volt appliances in Argentina, where 220-volt is the norm) and even bollixed up entire efforts (it pulled out of a loss-plagued Indonesian venture last year). In a joking reference to those cultural gaffes, John Menzer, Wal-Mart's head of international sales, says: "My goal is not to wear my underwear around my neck anywhere I go."

To that end, Wal-Mart has recently altered its strategy; instead of scattering stores around the globe, it's concentrating on becoming a major player in Europe. In December 1997, Wal-Mart snapped up the 21-store Wertkauf chain in Germany; a year later, it grabbed 74 more Interspar stores there. This year, in a blockbuster deal that shook up the once sleepy European market, Wal-Mart shelled out $10.8 billion to buy Britain's Asda, a 229-store Wal-Mart wannabe. "We've been a little too spread out," admits Menzer, who served as Wal-Mart's chief financial officer before he took over the international division following the Asda deal. "We're going to try to fill in regions."

The response in Europe to Wal-Mart's incursion was immediate and dramatic. Competitors scrambled to match Wal-Mart's low prices, long hours and friendly service. Then, before summer was out, France's Carrefour chain of hypermarkets had combined forces with its smaller competitor, Promodes, in a $16.5 billion deal--and rumors were flying about who would be next.

Because of stubborn local regulations, it's often easier for Wal-Mart to buy existing stores in Europe than to build new ones. But it still plans to put up lots of bricks and mortar in Europe and elsewhere around the globe. Menzer says he will open 90 to 100 stores a year overseas for the next three to five years. His target: doubling sales this year and again next year. Last year, international stores provided just 9% of Wal-Mart's total sales. Analysts say that figure should reach 20% by 2001. Looking further, Menzer has his sights set on hitting the $100 billion mark by 2010.


Wal-Mart would certainly seem to be far behind, eToys, eBay and the other e-tailers racing to become "the Wal-Mart of the Web." But ultimately, Wal-Mart may be more likely to claim that title than the upstarts, contends Brian James, a retail analyst at Loomis Sayles & Co., an institutional shareholder of Wal-Mart: "If the Internet becomes a way to make money, Wal-Mart will be there, and Wal-Mart will be bigger than anybody else."

Today, online sales are "peanuts" for Wal-Mart, says James. But the potential market could be huge, particularly as more of the middle-American shoppers who frequent Wal-Mart's stores go online. Consulting firm Forrester Research figures that sales on the Net will soar to $184 billion by 2004, a more than ninefold increase over this year's expected $20 billion, as the number of households shopping online nearly triples to 49 million. Seema Williams, the e-commerce analyst who wrote the Forrester report, figures Wal-Mart will "sweep the market in categories it is strong in."

Indeed, Wal-Mart seems to have all the key ingredients for online success: one of the most recognizable brand names in the country, pricing power and unparalleled distribution capacity (see "The Smart Way to Invest in Net Stocks" on page 118). So far, however, Wal-Mart is moving slowly. CEO Glass explains: "You have to offer convenience at a price that is competitive, and I don't think anyone has figured out how to do that and make a decent return on the investment."

Of course, Glass has Wal-Mart working hard to solve the riddle. For two years, without fanfare or heavy advertising, it has been testing, gathering data about who's buying and what products they want. The online store offers roughly 42,000 items (vs. 100,000 in a typical supercenter). As in its stores, Wal-Mart slashes prices to draw customers; some online-only specials are designed to undercut the prices of well-known e-tailers--if only by a few cents. Among its recent promotions: best-selling author Frank McCourt's memoir 'Tis for $13, $2.60 less than, and Millennium Barbie, dressed in a blue gown, for $32.87, 12[cents] lower than eToys.

Wal-Mart was expected to relaunch the site in time for the holidays but has now postponed the overhaul until the new year to avoid potential problems during the peak selling season. With the relaunch, Wal-Mart will offer an astounding 600,000 items--far more than any existing Wal-Mart carries. Website users will also be able to buy airline tickets, make rental-car reservations, fill prescriptions and send digital photos. In what's called a "clicks and mortar" strategy, Wal-Mart will use its stores to bolster its online operations and vice versa. Customers can already shop in cyberspace and then pick up their goods, prepacked, at the closest Wal-Mart. And Wal-Mart is testing a program that introduces its traditional shoppers to the Internet through in-store kiosks, where, for example, they can order computers not stocked in the store. "You've seen Wal-Mart win every skirmish in its land-based wars," says Burt Flickinger III, a consultant at Reach Marketing, who has studied Wal-Mart for 30 years. "There's going to be hell to pay for Internet entrepreneurs when they face the logistical brilliance of Wal-Mart."


Anyone buying the stock today is betting that Wal-Mart can sustain its remarkable growth record. Wal-Mart is known for its operational skills. But continued expansion for a company already so huge is fraught with uncertainty, if only because no store has ever been this big before. For example, although Wal-Mart's execs say they aren't worried about oversaturation in the U.S., finding places to put new stores has been getting tougher as communities from Greenfield, Mass. to Eureka, Calif. fight to keep Wal-Mart out. And while it dwarfs its rivals, it still has plenty of competition. K Mart, now on the mend, has begun opening its own superstores. Overseas, companies like Carrefour don't roll over easily. The Internet remains a big unknown. And while Wal-Mart is less vulnerable to economic swings than most retailers, it would still suffer in a recession.

Perhaps the biggest risk right now, however, is the lofty valuation of Wal-Mart shares. The stock consistently commands a premium over other retailers and the S&P 500. At its recent $55, it trades at 48 times latest 12-month earnings--vs. 28 for the S&P 500--and 39 times next year's consensus earnings estimate of $1.40 a share. That's near the top of its historical P/E range and certainly seems like a lot to pay for a company with 3.3% profit margins and a 15% earnings growth rate. Wal-Mart's high P/E increases the danger for investors should the company stumble--or even if it simply fails to expand as fast as Wall Street expects it to. Those are issues you should consider before investing.

In essence, the case for buying Wal-Mart stock sounds a lot like the argument for buying New Economy stocks like Microsoft, Lucent or even America Online. Wal-Mart is by far the dominant company in its business, it has one of the most consistent track records of earnings growth, and its profitability on most key measures--including operating margins, return on assets and sales per square foot--keeps on getting better. This may not be the glitziest company in America, but it is one of the most admired and best-run ones. "Does Wal-Mart fit into the camp of an inexpensive stock by traditional valuation measures? Absolutely not," says Tim Ghriskey, a portfolio manager at Dreyfus, which owns Wal-Mart stock and has no plans to sell. "You cannot justify it. But it is a good example of a company that should carry a high multiple. It is a dominating company, and it is worth a premium to the market and to the group."

If history is any guide, it doesn't pay to bet against this Goliath. Seven years ago, when Sam Walton died, Wall Street questioned whether the company could continue to prosper without him. Today, there is no doubt that it has. And the people with the most riding on Wal-Mart are confident. In rare public comments from his windowless office, Wal-Mart chairman Rob Walton says that he, his mother and three siblings, whose 38% share of the company is worth $89 billion, haven't pared that stake since Sam's death and have no plans to start. "I feel really good about where Wal-Mart is," he says. A lot of smaller shareholders would have to agree.