Wild Oats Withers

The big news today for Wild Oats Markets (Nasdaq: OATS  ) is its downgrade to "neutral" by Prudential. But there's a lot more to learn about investing from this unfortunate stock.

Natural and organic foods are hot investments right now. Look at United Natural Foods (Nasdaq: UNFI  ) , the U.S.'s leading distributor of natural and organic foods. For the last five years, the company has compounded earnings by 21.8%, and analysts expect the company to produce 19% gains for the next five years. As you might expect, Wall Street has rewarded the stock, trading it for 29.9 times trailing earnings.

One of the hottest stocks on Wall Street -- and a Motley Fool Stock Advisor recommendation -- is Whole Foods Market (Nasdaq: WFMI  ) . It's No. 1 among organic-food supermarkets. Sales have soared 43.7% in the last two fiscal years. Compounded annual earnings have grown by 19.6% over the last five years, and analysts see 20% growth ahead for the next five. That success has led to a trailing P/E of 78 -- a huge reward for Whole Foods shareholders.

Consider this long-term chart of Whole Foods compared to Wild Oats. Whole Foods investors have steadily bagged a lot of greenbacks, while Wild Oats' stock has gone up, down, and ultimately nowhere in particular.

Its lack of success can be explained by its lack of meaningful earnings. From April 2004 to March 2005, Wild Oats lost $1.72 a share. Ouch! The quarter before last saw the company's fortunes improve slightly, as it earned $0.03 a share. But last quarter, the company earned just $82,000. In the company's results, that pittance doesn't even round up to a single penny of per-share earnings.

What can Fools learn from Wild Oats? First, owning the No. 2 company in a hot sector isn't necessarily an automatic win. Over the last two completed fiscal years, Wild Oats has grown sales by just 14%. Worse yet, trailing-twelve-month operating margins of 0.03% show that its revenues just haven't trickled down to the bottom line.

Second, poor performance doesn't always lead to a stock being undervalued. Analysts remain optimistic about Wild Oats' future, expecting the company to compound earnings by 15% a year for the next five years. Even so, the stock trades for a hefty 42.2 times next year's projected earnings.

The final lesson is that is pays to watch operating margins. Whole Foods' trailing annual operating margin of 5.2% exceeds the supermarket industry's 3.1% average. It's capitalizing on its position in a hot sector -- and Wild Oats, with its puny 0.03% trailing margins, is not.

Whole Foods' healthy margins help to give it an uncharacteristically strong balance sheet, with net cash (cash minus debt) of $289.7 million and a 1.4% total debt-to-equity ratio. Compare that to debt-heavy competitors Wild Oats, Kroger (NYSE: KR  ) , Safeway (NYSE: SWY  ) , and Albertson's (NYSE: ABS  ) . They carry debt-to-equity ratios of 140.5%, 177.2%, 135%, and 120.3% respectively. Debt has its price, and Whole Foods is laboring with a whole lot less than its peers.

Wild Oats is a troubled company selling at a strong future multiple to earnings. Yes, it's in a hot segment, but it's failing to capitalize on that advantage. Investors would be wise to sow their investment dollars elsewhere.

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Fool contributor W.D. Crotty does not own any shares in the companies mentioned. Clickhereto see The Motley Fool's disclosure policy.


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