Shares of WalMart (NYSE:WMT) are finally starting to show signs of a slowdown after a major rally. WMT stock ripped higher by more than 20% from the mid-March lows and is one of the few stocks higher in 2020.
This move took WalMart to fresh new all-time highs as investors deemed the stock immune from covid contagion. While the short term benefit of the crisis is undeniable, for the longer term, WMT stock is looking overvalued and overbought. It’s time to take profits and check out of WalMart.
The Valuation View of Walmart
The fundamentals for WMT stock are looking a little stretched on a comparative basis. The current price-earnings ratio is at 25 and is by far WMT’s highest multiple over the past five years. Other metrics, such as price-sales and price-free cash flow, are at similar extremes.
The dividend yield for WMT is back below 2% and now below the yield on the S&P 500. The PEG ratio, which compares P/E to growth, is approaching 5 and nearly twice the industry average. WMT stock is not cheap at current levels.
It’s interesting to note that the last time WMT stock had such a big P/E multiple expansion was early 2018 which equated to a major top in the stock.
The analysts tend to agree that WMT stock is reaching a top. TipRanks shows the average analysts price target at $131.53, which is close to its current price of $129. Even the most bullish price target is just $145. Not exactly an overly optimistic consensus from the usually bullish stock analyst crowd.
Earnings are due May 19 for WalMart. Consensus estimates are for $1.16 in earnings on $127 billion in revenues. This is a slight increase from a year ago when EPS came in at $1.13. Of course, back then WMT stock was near $100, not the $129 levels seen today. Guidance and the impact of COVID will likely outshadow earnings for this quarterly report.
Both earnings and guidance may likely to disappoint given the recent red-hot run up in WMT stock. This is especially true considering any further multiple expansion seems unlikely.
The Technical View of Walmart
WMT stock had gotten decidedly overbought from a technical perspective. MACD soared past 1 to the highest readings in the past three years before it weakened considerably. The nine-day RSI printed above 70 before it weakened as well. Momentum rocketed to a multi-year high then crashed back to reality. Shares are trading at a massive premium to the 20-day moving average, which has led to pullbacks in the past.
There is major overhead resistance at the $133 area. Previous times these indicators all flashed red marked significant short-term tops in WMT stock.
More importantly, WMT stock tried and failed on three separate occasions to break out to new highs past the $133 resistance level. That failure signifies that the buyers may finally be exhausted and that the sellers are in control. It is even more meaningful given the magnitude of the previous rally.
Implied volatility is still elevated in Walmart options which favors selling strategies when constructing trades. So in place of shorting WMT stock outright, a defined risk out-of-the money bear call spread is a lower risk-and lower cost- alternative.
How to Trade Walmart Stock
Sell WMT May $136/$140 call spread for 70 cents net credit
Maximum gain on the trade is $70 per spread with maximum risk of $330 per spread. Return on risk is 21%. The short $136 strike price provides a 5.8% upside cushion to the $128.53 closing price of WMT stock. Expiration is May 15, meaning that the trade will expire before earnings are due. This will likely dampen volatility and further lower the risk. The short strike price is structured well past the all-time intraday high of $133.38 in WMT stock.
As of this writing, Tim Biggam did not hold a position in any of the aforementioned securities. Anyone interested in finding out more about option-based strategies or fora weekly option and volatility newsletter can visit the Options and Volatility Newsletter website.
