Wouldn't it be nice if you could go back in time and invest in Whole Foods Market (WFM)? Believe it or not, you might have a second chance to do so. I recently wrote an article: "Kroger (KR 0.22%) and Whole Foods Are for Different Types of Investors." Perhaps you read it. If not, I included a quick comparison to Sprouts Farmers Market (SFM -0.07%). After completing the article, I decided to go back and do more research on Sprouts Farmers Market. What I found was very intriguing.
Will Sprouts continue to sprout?
In 2002, Sprouts Farmers Market had one location, located in Chandler, Arizona. Today, it has 165 locations across eight states. This still makes Sprouts Farmers Market relatively small, and that's excellent news for investors.
Sprouts Farmers Market is highly likely to expand. When a new store expands, it tends to attract a deluge of customers because of the novelty. This in itself is a potential top-line catalyst. In many cases, the novelty eventually wears off. However, in some cases, such as in the case of Sprouts Farmers Market, the store offers something unique enough that it builds a strong loyal customer base.
Loyal customers
Sprouts Farmers Market is set up to look like an open-air farmer's market, hence the name. When you walk through its doors, you will hear lively 50s and 60s music, and you're likely to be greeted with a smile. Sprouts Farmers Market takes the laid-back and fun approach to customer service. You will also notice the fresh produce section in the middle of the store. Most grocery stores have their fresh produce off to one side. Sprouts Farmers Market figured that having its most popular section on center display would make sense.
When you walk around the store, you will also find low shelving; wide-open aisles for easy maneuverability; wooden crates and barrels filled with various items, including candy, grains, nuts, coffee and flour; a deli counter with made-to-order sandwiches, a full-service meat and seafood center, including homemade hamburgers and sausages; and a large selection of vitamins and supplements with a trained and knowledgeable staff to explain the benefits of these vitamins and supplements.
All of these features combined lead to customer loyalty. As you might already be able to tell, Sprouts Farmers Market offers a unique shopping experience, and some might even refer to it as a happy shopping experience. However, the biggest selling point of all, for customers as well as investors, is that Sprouts Farmers Market offers differentiation by offering "Healthy Living for Less."
This is the company's slogan, and it's what separates Sprouts Farmers Market from Whole Foods, where customers often have to pay a premium for natural and organic foods. This has led to great success for Whole Foods, but if consumers are struggling and both options are available in a geographical sense, then they're more likely to visit Sprouts Farmers Market. Whole Foods doesn't have to worry too much yet, as it has more than twice as many stores, but it might want to begin looking over its shoulder.
Comparison to Whole Foods Market and Kroger
The one potential negative for Sprouts Farmers Market, at least from an investing standpoint, is that it's currently trading at 64 times forward earnings. This makes it much more expensive than Whole Foods and Kroger, which are trading at 29 and 13 times forward earnings, respectively. However, it seems as though Sprouts Farmers Market is more than capable of growing into its multiple if its recent top-line trend remains intact:
SFM Revenue (TTM) data by YCharts
After investors see strong top-line growth, they often want to know about the bottom line. After all, many young companies that show strong top-line growth lag on the bottom line. Fortunately, this isn't the case for Sprouts Farmers Market:
SFM Net Income (TTM) data by YCharts
That said, it should be noted that by offering "Healthy Living for Less," Sprouts Farmers Market has very thin margins. For instance, its profit margin of 1.97% leaves little room for error. That said, the same is true for Amazon, which seems to be doing just fine.
Another potential negative for Sprouts Farmers Market is that it doesn't pay a dividend. However, most young growth companies don't go this route. These companies want to use their cash flow to reinvest in the business for continued growth. This, in turn, often leads to stock appreciation.
If you're interested in a larger, more mature grocery store that generates a lot of cash flow and pays a dividend, then you might want to consider Kroger, which currently yields 1.60%. Whole Foods is somewhere in the middle, offering growth and shareholder rewards thanks to strong cash flow. Whole Foods currently yields 0.90%.
An organic growth play
Despite the rich valuation and current macroeconomic headwinds, Sprouts Farmers Market appears to have more upside potential than downside risk. Since it's a young company, there could be some big bumps in the road, but if you're looking at this from a long-term Foolish investment perspective, then there are few companies I like better than Sprouts Farmers Market when it comes to potential.
