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Friday Five: A Tale of Two Sell-Offs

Both Netflix and Wal-Mart shares slid this week, but only one looks like a bargain. Plus, tech's biggest deal ever, boring big bank earnings, and more.

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Jason Stipp: I'm Jason Stipp for Morningstar and welcome to The Friday Five, Morningstar's take on five stories in the market this week.

Joining me with The Friday Five is Morningstar markets editor Jeremy Glaser.

Jeremy, thanks for being here.

Jeremy Glaser: You're welcome, Jason.

Stipp: Up first this week, we had the biggest tech deal in history; Dell and EMC are combining. What's our take on this mega-deal?

Glaser: Dell and its private equity partner Silver Lake are going to spend about $67 billion to buy EMC and, like you mentioned, this will be at least in nominal terms the largest tech deal ever.

This deal allows Dell to provide integrated solutions--from networking to storage to servers--to their clients. It allows them to present an entire package. It also lets them expand more into enterprise. Traditionally, they've been strong on end users, small and medium businesses. This lets them get into some larger ones, given EMC's strong relationships with those companies.

Morningstar analyst Pete Wahlstrom thinks this deal also has the ability to shake up a lot of entrenched players across the entire industry. He mentions that firms like Cisco, HP, NetApp, and Citrix could be impacted over time.

Now, there will be integration issues. This isn't something that necessarily will happen overnight. But he thinks in the coming years, this deal is large enough to reshape a lot of these big enterprise companies, and it will be interesting to see how these other firms react.

Stipp: We got big banks earnings over the last few days, and you say they were pretty boring, which isn't necessarily a bad thing?

Glaser: It's actually a good thing. We're luckily past the point where the big bank earnings were something we were concerned about and were watched so closely by the market to see what's happening with the health of the banks and the health of the economy.

For the most part, things were pretty steady. The market volatility took its toll, as was expected. But in a lot of cases, the toll was not quite as much as people initially thought. That was a positive surprise. The interest rate environment continues to be a challenge for profitability for the banks.

There were some differences between the individual names. JPMorgan was struggling with legal expenses, but their loan growth looks pretty good, and they had some market issues there as well.

Wells Fargo is having very good credit quality, and we actually think after this results that it's clear that a dividend hike could be coming down the road in 2016--something a lot of Wells Fargo investors will be looking forward to.

Bank of America continued to show improvements, particularly when it comes to cutting costs. But they are having trouble showing any growth and where that growth is going to come from, a continuation of a trend we've been seeing.

Stipp: Retailing giant Wal-Mart put investors in a very bad mood Wednesday. What's the story?

Glaser: Wal-Mart released guidance for their fiscal 2017 year that was well below expectations. They think that earnings will be down 6% to as much as 12%, which is a much steeper decline than anybody expected.

They are continuing their investments in things like higher wages for their employees, in improving their stores, improving the shopping experience, and also investing in ecommerce. They've become more of an omni-channel retailer. These investments cost a lot of money. They are going to weigh on profits, and they don't think sales aren't going to suddenly rebound until they see these investments take hold, which is something that will take some time.

Our Wal-Mart analyst Ken Perkins thinks that right now the market is not giving any credit to these investments. The market is basically assuming that these are going to be abject failures, that they are not going to get any long-term profitability from it, and they are essentially throwing money away. Ken says that's certainly a possibility. There is a chance these investments won't work out and they aren't going to be able to execute this turnaround. But he doesn't think it's the most likely scenario. He thinks they will be able to see some benefit over time. Given how much the shares have sold off, he sees a lot of value in the company right now and thinks that long-term investors may want to take a much closer look at Wal-Mart today.

Stipp: Wal-Mart wasn't the only company that disappointed this week. Netflix also disappointed investors.

Glaser: It was all about subscriber growth, which is one of their key metrics that's looked at. International growth actually looked pretty good. That an area is a key future driver for them. U.S. subscribers were up but not as much as expected. That seemed to spook the market a little bit. This comes as Netflix is trying to push a price increase for new customers. As they are trying to invest more in original content, they see that as the future of the company--having content that's only available on Netflix.

Neil Macker, who covers Netflix for Morningstar, thinks that investing in original content does makes sense, and is something that could be profitable over time. So, I don't think Netflix's focus on that has the market concerned. I think this could just be a simple valuation issue. There are very high expectations baked into Netflix right now, and when you see a quarter where things don't look spectacular, shares sell off.

But even after the big decline in Netflix shares, they are still overvalued. They are still trading well above what we think they are worth, and people who are interested in Netflix might want to wait for an even further decline before taking a position.

Stipp: Lastly, payments firm Square unveiled plans for its IPO. You took a first look at those. What's your impression?

Glaser: We talked about Jack Dorsey just last week. He has now been named the permanent CEO of Twitter. We mentioned that he was also the CEO of Square. He is going to be a lot busier as the CEO of Square, at least in the near term as they get ready for this IPO.

They are looking to raise around $275 million, and that could change before the actual IPO date. These things tend to get revised quite a bit.

This is a company that's been much buzzed-about for quite a long time. A lot of startups have been trying to get into the payment space. And you have players like Apple trying to get into the payments space.

Getting a look at the financials has been interesting. It shows a pattern of relatively strong revenue growth--they were able to grow the top-line--but profitability … the losses keep getting bigger and bigger. They are not able to do that profitably. There also are some other things on the horizon. They are losing a deal with Starbucks that makes up a big chunk of revenue. How are they going to deal with some of those issues that crop up. So, we'll take a closer look at this one as we get more information, as we get closer to the IPO date.

Investors who are interesting in payments can look at narrow-moat PayPal right now. It's not a screaming buy, but it is trading below our fair value estimate, and it could be an interesting play in payments if that's something you are interested in.

Stipp: Lots of headlines in the news this week. Thanks for keeping us on top of it.

Glaser: You're welcome, Jason.

Stipp: For Morningstar, I'm Jason Stipp. Thanks for watching.

Jason Stipp does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.