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Why I'm Buying Whole Foods Before Other Investors Realize Their Mistake

One of the long-term investor's greatest advantages is the utilization of a concept known as time arbitrage. Investopedia defines time arbitrage as:

An opportunity created when a stock misses its mark and is sold based on a short-term outlook with little change in the long-term prospects of the company. This miss occurs when a company fails to meet earnings estimates by analysts or its guidance, resulting in a short-term stumble where the price of the stock decreases. Some investors use time arbitrage to increase their chances of outperforming the market.

Basically this means that as long-term investors, we can use Wall Street's short-term focus to our advantage. As the sell-first-and-ask-questions-later crowd is running for the exits, we can calmly step in and buy shares of great businesses at more attractive prices.

But here's the key: We must have confidence that the business's long-term competitive advantages are still intact. Otherwise, we may be stepping in front of a bus. For if the company's short-term struggles are signs of further danger ahead, buying ahead of that decline will lead to steep losses. However, if nearsighted traders are overestimating the impact of a temporary downturn in a company's business performance, buying into that weakness could give long-term-minded Fools a powerful profit opportunity.

The ability to tell the difference between a business that is in a state of decline and one that is only temporarily struggling and poised for a rebound is often a key factor in whether an investor can earn market-beating returns. At Tier 1 Investments, a Motley Fool Real-Money Portfolio, I've used time arbitrage to help us achieve a 33.87% return since Tier 1 was launched on Sept. 1, 2011, besting the S&P 500 by 421 basis points over that time. And today, I believe I've found another time arbitrage opportunity in Whole Foods Market (NASDAQ: WFM  ) .

The sell-off
Whole Foods' shares are down around 10% since it reported first-quarter results that disappointed Wall Street. The natural-foods grocer beat earnings-per-share expectations by a penny and rang in revenue right in line with estimates, but same-store sales growth of 7.2% fell short, and Whole Foods reduced guidance for the rest of the year. Management also stated that gross margin will likely come under pressure in the coming quarters as Whole Foods expands its value offerings in what can be viewed as an attempt to shed the "Whole Paycheck" moniker and strengthen the value perception of its brand.

The risk
Many traders are concerned that Whole Foods is playing defense by sacrificing gross margins in order to preserve sales that would otherwise be lost to competitors. These bears argue that because of this, Whole Foods no longer deserves its premium valuation, and its stock should continue to decline in price.

I respectfully disagree.

The opportunity
While there's no denying that competition in the natural and organic foods market has increased, I believe that Whole Foods is going on the offensive by appealing more to the value-conscious consumer and, by doing so, expanding its addressable market. Here's a key passage from Whole Foods' most recent earnings call that touches on this point:

[Whole Foods executive:] Yes, we're going to keep investing in price. You say, the gaps narrowed, that's true. We'd like to eliminate it while maintaining high quality. We think that's a competitively very strong position to be in. So yes, we're going to continue. This is very important. We think that our competition is increasing around the country. And we think that we're going to continue to invest in price. We're going to continue to try to improve our value proposition while continuing to differentiate and evolve our product mix. We can do both.

[Walter Robb:] Let me add a little, this is Walter. I'm just going to say that ... it's a really moving environment out there and we want to give ourselves the room to be able to continue to improve our position. And the bigger prize here ... is that the market is getting bigger and we're going for the big prize, which is those folks that are not eating as healthy. The fresh healthy food market is very large. And we think by continuing to improve our position we have access to a much bigger market than we're currently serving. So this is an important point: giving ourselves the room to continue to do this. ...

[Analyst:] But just to paraphrase, is it fair to say you don't really see any change in the environment from a competitive or consumer perspective? You just think this is an opportunity to continue to gain share?

[Whole Foods executive:] That's what we're thinking, that's our strategy. Yes, that's how we see it.

If these "investments in price" allow Whole Foods to boost sales by taking market share from rivals, the moves will be cheered by the market. I want to buy ahead of that -- before other investors realize their mistake.

The Foolish bottom line
I like businesses that are unafraid to sacrifice short-term profits in order to deliver more value to consumers, because those that do are often rewarded in the long run. By applying the concept of time arbitrage, we can take advantage of temporary market fear to build out our long-term ownership stakes in elite, Tier 1 enterprises at attractive prices. And so 24 hours after this article is published, I will be increasing Tier 1's position in Whole Foods.

And if you'd like more in-depth research on Whole Foods, be sure to check out the Fool's premium report on the company, in which we walk through the key must-know items for every Whole Foods investor, including more on the main opportunities and threats facing the company. Make sure to claim your copy today by clicking here.

Read/Post Comments (2) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On March 30, 2013, at 9:30 AM, Ernesto9999 wrote:

    Management's discussion about "investing in value" is a red herring. There is some of that going on, so it's partially true. But the real issue is that the company COULD grow to 1000 stores but doesn't have the managerial know-how or structure do so, while its competitors do.

    Meanwhile, conventional retailers such as Costco, Giant, Publix, Hannaford, and Target aren't stupid. They've dramatically expanded their natural and organic offerings, coffee bars and prepared and specialty foods, and it's working. And with no e-commerce, WFM has bungled its brand advantage and allowed Amazon and to become the online destination of choice for cases of natural grocery products.

    As for customer and employee satisfaction, the numbers aren't what they used to be and they're heading in the wrong direction. Check the surveys in Consumer Reports and Fortune Magazine.

    Of course, with almost daily puff pieces on the company, management is convinced it's infallible. The issues at WFM go way beyond matching competitors' prices on some pantry staples. Investors should be cautious of buying any stock where the underlying business trend for the firm is not favorable, analysts are still painting a rosy scenario and the stock still has lofty P/E and PEG ratios despite six months of exceptionally weak performance as the Dow and S&P hit multi-year highs.

  • Report this Comment On April 17, 2014, at 5:20 PM, MLMarkow wrote:

    Whole Foods never intended to be the "cheap" alternative. It's focus on healthy "clean" foods has created a loyal customer base who trusts WFM. I don't necessarily trust my local giant chain store, even if they claim a product is "organic". That customer base will continue to support WFM's growth. I currently travel a significnat distance to shop in their store and would give them more business if they had a closer location.

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9/30/2016 4:00 PM
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Whole Foods Market CAPS Rating: ****