The month of February has been a good one for our seasonal short positions. Prior to 2022 Q4 earnings, Walmart (WMT) was our most profitable position – now it is our 4th. We took this position because of the large payoff in the short position from a risk / reward perspective but will be switching to a long position in March.
Today, we’ll explain why.
Walmart usually ends February in the green. However, the risk / reward favors the bears. In the past 40 years, WMT has made gains in February 60% of the time, with an average upward movement of 87 cents; the other 40% of the time produced average downward movements of $ 3.07.
The result of these facts is a negative expected value. Were you to short WMT over February consistently, not only would you emerge unscathed but you would have seen an ROI of 24%. Below is the performance of a seasonal long position of WMT versus buy-and-hold; clearly, holding WMT over February is a losing game over time:
Fortunately for WMT bulls, the February weakness seems to be limited to February. March’s performances are of high alpha, producing gains way above what is statistically expected in an average month. In fact, March accounts for 23% of WMT’s total gains, essentially making your money grow at 4 times the average speed:
Of course, many SA readers are opposed to market-timing and seasonality, which I find quite sad. At the same time, I do not want anyone feeling that this is a bunch of mathematical voodoo, and so I have a pretty reasonable explanation for these patterns:
February tends to be bad because it contains Q4 earnings, which – according to my backtests – tends to have the worst earnings reports. Investors sell, and dip-buying occurs after the overreaction, apparently in March, when enough people buy to cause a rally. All things being equal, this is what we should expect over the average year.
But we can do a bit better in our predictions by actually analyzing the earnings call.
Earnings Call Lexical Analysis
Text-based sentiment analysis has become one of the most popular forms of financial analysis in the business intelligence field and has become increasingly employed in predicting stock prices. My own form of this analysis is applying statement-level (ie, treating forward-looking statements as the smallest unit) lexical analysis to earnings call transcripts, labeling the statements as either pessimistic or optimistic. I’ve written code to do this for me, calculating a sentiment score by subtracting the number of pessimistic statements from the optimistic ones, then scaling by the length of the earnings call so that I can compare scores across different quarters.
I’ve done this for Walmart’s earnings calls over the past two years, allowing me to see the changes in sentiment over time. I’ve also labeled sentiment changes on WMT’s chart, and it does appear – as it does with most other stocks – that this sentiment analysis tends to predict the direction of the stock rather accurately. Here is the story thus far:
The story of WMT’s sentiment over the past two years has been one tinted by a struggle to tread above average. This helps explain WMT’s general walk to nowhere; indeed, the stock price is pretty much where it was two years ago. Sentiment tends to be low when a company does not have many exciting projects or tailwinds; stagnation is the main attribute of average sentiment.
But there is good news: The sentiment score for the recent quarter has jumped precipitously. Sentiment is a staggering 40% higher in optimism this quarter as compared to last quarter and 111% higher as compared to last year. This is the first quarter in the past two years with a sentiment score significantly above average, predicting alpha – or excess returns – over the coming quarter.
Let’s check a few of the bullish statements flagged in my analysis to better understand the bump in sentiment. My comments follow.
“We increased share repurchases significantly this year with buybacks of just under $ 10 billion, a pace we plan to continue or increase in the coming year given our view of the long-term value of the company.”
-Although many investors prefer special dividends and dividend raises to share repurchases, buybacks do have alpha-producing effects on a stock. Buybacks have been shown to produce, on average, an extra 20% to 30% in stock returns four years after the buybacks. In addition, buybacks only impose taxes on shareholders who sell their shares, whereas dividends impose taxes on all shareholders.
“At a time when prices are rising in so many parts of the economy, being able to offer customer value and find inflation is what we do.”
-This is in regard to an announcement of increasing price rollbacks. This is not a timid move, by any measure, but it is a pretty interesting one in that it sacrifices margins for maintaining / improving the company’s unique selling proposition. While other companies raise prices during the inflationary environment, Walmart lowers prices. From a marketing perspective, this is likely to lead to good word-of-mouth advertising, which is generally considered the best type of advertising in this industry. This year, Walmart saw record sales numbers. It’s not hard to imagine another record in sales with price rollbacks during inflation, and so I believe Walmart management is focusing on this metric with ardor.
“We added more than 20,000 new sellers to the platform in the US last year, and expect to add nearly 40,000 more this year.”
-That’s guidance of double growth for next year in this category. Walmart’s employment of the Amazon (AMZN) style selling platform is smart from a margin perspective. Profits are low when you’re the retail middleman, and offering a platform instead allows for scale at low cost. Amazon learned this a while ago, which is why you can no longer filter Amazon.com’s search results for products sold by Amazon; it’s simply more profitable to offer the platform to individual sellers. Walmart’s growth in this segment is a step toward increasing overall profitability and another step toward bolstering its business against the Amazon threat.
“While e-commerce penetration approached 13% Walmart US grew sales by more than $ 23 billion and saw strong market share gains in food and consumables. Over the past two years, our US segments have grown sales by $ 67 billion, or 17%, and operating income by 25%. ”
-As we just discussed the Amazon threat, let me remind you of a few years ago, when analysts were claiming Walmart’s food and consumables business would end due to Amazon moving into the segment. I responded with an article – my last article on Walmart – dismissing the concerns and giving a price target of $ 138 for WMT (WMT was trading at under $ 100 at the time). Clearly, the fears were overblown, as this year Walmart has again increased its market share in this segment.
Important here, too, is the operating income growth of 25% over the past two years; this is a metric we should pay special attention to, as raw sales and revenue are pretty useless as metrics for Walmart (WMT’s sales and revenue numbers are larger than those of Apple, for example, but profitability is nowhere near Apple’s).
Overall, Walmart’s recent earnings report and the appended call show the company in a strong growth phase, with even stronger growth upcoming. Sentiment points to a buy-in at this point. Seasonality agrees.
In our seasonal portfolio, we will remain short through February due to the rules I’ve used to chisel out this portfolio, but we will likely switch to a long position in March. We remain profitable with this short at present, but the strong guidance from the Q4 earnings report should silence the voices of WMT bears for the coming months and year. I am considering to hedge my short position on WMT for the rest of February with the following play, which I would recommend to anyone wanting to go long on WMT at this point:
Sell Mar11 $ 135 puts
These puts currently sell at $ 280 each, and you will keep that premium as long as WMT is above $ 135 by March 11. Some investors proscribe puts as dangerous due to the almost unlimited downside risk, but the risk profile is actually the same as that of holding stock. So, if you are willing to hold stock that can potentially go to zero, you should be willing to sell puts just the same.
The selloff after the earnings bump is likely due to the market dragging everything down (a falling tide sinks all ships). WMT has a pretty strong support level in the mid- $ 130s, and I think $ 135 is a good buy-in point if you want to buy near a relative bottom. I like short puts here because we’ll be able to profit even if WMT trends sideways for a bit before the bullish March seasonality.
Let me know what you think about this play.