It's Time to Start Buying Whole Foods

The stock's fall from grace offers long-term investors the chance they've been waiting for.

May 13, 2014 at 9:40AM

Depending on how you look at it, Whole Foods Market (NASDAQ:WFM) investors either received a blessing or a curse last week, after disappointing earnings sent the stock falling almost 20%. Obviously, it's never fun to watch a stock you own lose a fifth of its value in a single day, but if the business is still sound, it presents a great opportunity to add to your position, or start one if you haven't already. Read on to see why I believe Whole Foods investors are being presented with just such an opportunity.

The bear case
There's no denying the fact that Whole Foods has some challenges ahead. The company used to only really compete with other premium grocers, but now, everyone from Wal-Mart to Trader Joe's is a potential competitor, as the lower end of the grocery retail space has begun adding more organic options.

This is a long-term problem that isn't going to go away. Largely thanks to Whole Foods itself, the grocery industry has made a likely permanent change toward healthier food. That's great for consumers, but it's had the effect of drying up the moat around Whole Foods' business. Why buy the same organic pasta at "Whole Paycheck" that you can get for significantly less on sale at Wal-Mart or Safeway?

In order to fend off lower-priced rivals, Whole Foods has had to fight fire with fire and lower its own prices. Thus, even as Whole Foods reached record sales this quarter, gross margin fell by 52 basis points, ultimately leading to flat earnings growth.

Flat earnings growth is not what investors want to see from a company with a price-to-earnings ratio roughly twice that of the market average. Even after the market reaction, the company's P/E is still quite high, and the price-to-earnings-to-growth ratio sits at 3.0. Anything over 1.0 is considered higher than the growth would warrant, so Whole Foods would still seem overvalued.

The bull case
The bull case, to put it bluntly, is that this is still Whole Foods.

Even after revising its 2014 outlook lower for the third time, the company is still expecting double-digit sales growth for the year. Granted, it came close to that this quarter with no growth in earnings, but the expectation is that as the company lowers prices to attract new customers, the sales growth will eventually overcome the margin compression. And with a gross margin of 35.8% this quarter, Whole Foods has margin to spare. Only one competitor (The Fresh Market) comes close to that, and Whole Foods still has a 200-basis-point lead.

It's likely the needed sales growth will come as the company continues "investing" in price cutting. While it's true that grocery products are fungible in the sense that it doesn't matter if you buy a box of organic pasta from Whole Foods or that same box from a competitor, Whole Foods isn't just selling products out of a void. Whole Foods also sells a certain experience that customers aren't going to get from cheaper competitors. It's easy to laugh at the idea of knowing exactly where your free-range salmon came from, or what the name of your Kobe beef's masseuse was, but at a certain price point, I think a lot of people would rather have that shopping experience than whatever Wal-Mart offers.

Growth will also come from expansion, as the company grows from an expected 398 stores at the end of this year to 575 by 2018, and a long-term goal of 1,200 in the United States. That, coupled with gradually lower operating costs intended to offset lower gross margin, will see the company to $2.2 billion in EBITDA by 2018, according to its vision statement.

Obviously, after three recent downward revisions, its track record for future estimates isn't that great, and it's anyone's guess what will happen by 2018, so that EBITDA should be taken with a grain of salt. But even with today's numbers, the company has an enterprise value-to-EBITDA ratio of 10.6, only a modest premium over low-end competitors that have less growth potential.

The Foolish bottom line
Let me be clear: I don't think Whole Foods is a screaming buy right now. The challenges it will face over the next few years are not to be taken lightly, and the market has punished the stock in part over worries that the company is in fact taking these challenges lightly. Even after that punishment, the stock still carries a premium valuation. But if you believe Whole Foods is unique within the grocery industry, it sure is tempting to buy the stock at its lowest valuation in years.

Top dividend stocks for the next decade
The smartest investors know that dividend stocks simply crush their non-dividend-paying counterparts over the long term. That's beyond dispute. They also know that a well-constructed dividend portfolio creates wealth steadily, while still allowing you to sleep like a baby. Knowing how valuable such a portfolio might be, our top analysts put together a report on a group of high-yielding stocks that should be in any income investor's portfolio. To see our free report on these stocks, just click here now.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool’s board of directors. Jacob Roche has no position in any stocks mentioned. The Motley Fool recommends The Fresh Market and Whole Foods Market. The Motley Fool owns shares of Whole Foods Market. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers