Putting My Money Where My Mouth Is: Why I'm Buying Whole Foods Market Inc. Stock Now

"Whole Foods Is Getting Its Organic Lunch Eaten"

"Whole Foods Started a Food Fight"

"Could Whole Foods Meltdown Drive Gains Elsewhere?"

The beginning investor could be forgiven for thinking that Whole Foods Market's  (NASDAQ: WFM  ) business was drying up and that it's preparing to file bankruptcy, based on last week's headlines. While nothing could be further from the truth, the company's earnings report did contain more than a few disheartening tidbits for investors -- causing the company's stock to drop by as much as 20%.

Simply put: Investors are worried that Whole Foods is damned if they do, and damned if they don't -- especially when it comes to competition. Should the company lower prices on its goods, it would compete with Kroger (NYSE: KR  ) and Wal-Mart (NYSE: WMT  ) on price, but could lose what makes it distinctive. On the other hand, if Whole Foods doesn't lower prices, it could retain its differentiation, but new customers will continue to migrate toward other grocers in the quickly crowding organic/natural food space.

Indeed, there was a lot of "bad news" to digest from the company's latest earnings report: missing expectations on revenue and profit, while lowering forecasts for the rest of the year. But as I intend to show below, Whole Foods still has its best days in front of it, and I plan on putting my money on that sentiment.

Lowering prices won't ruin the brand
If there's one thing anyone who's shopped at Whole Foods knows, it's that going there is just as much about the experience as it is about getting food. That probably sounds obnoxiously snooty, but it's an easily demonstrated fact -- and it has helped the company grow to where it is today.

That's going to be an incredibly important differentiator moving forward, as Wal-Mart, Kroger, and Safeway come out with lower-cost organics, and The Fresh Market (NASDAQ: TFM  ) , Sprouts Farmers Market, and Natural Grocers by Vitamin Cottage (NYSE: NGVC  ) double down on the strength of the organic movement.

To get an idea for just how far ahead of the competition Whole Foods is, take a look at how different the average employee's experience is at Whole Foods, as compared to the rest of the competition, according to reviews submitted to Glassdoor.com.

Source: Glassdoor. Kroger CEO did not have any current reviews.

I consider these employee opinions to be a fair proxy for the overall culture and vibe at a grocery store. If, as a shopper, I have the choice of going to Kroger or Whole Foods -- which both have organic goods for about the same price -- there's no doubt I'd rather spend my time at Whole Foods.

The fact of the matter is, if Whole Foods truly is reducing prices, it will take time for that message to filter down to the customers, meaning that while traffic might not pick up in the near term, it will over the long haul. As long as "lowering prices" doesn't mean "lowering the bar on customer experience," the drag between point A and point B here is the zone of opportunity for investors.

Easily the best player in the industry
But Whole Foods is also more than just a feel-good, hippie, fun-to-visit location. It is also a seriously successful capitalist organization. By almost any given metric, the company is heads and shoulders above the competition.

Source: SEC filings for FY 2013. Wal-Mart not included as it sells far more than just groceries.

The fact that Whole Foods is so far ahead of traditional grocers should be no surprise. But the difference between Whole Foods and the trio of upstarts -- Sprouts, Fresh Market, and Natural Grocers -- is important.

All three of these natural/organic-focused players have significantly smaller store sizes than a typical Whole Foods. That means that if I'm a health-conscious shopper, there's a much better chance that Whole Foods could meet all of my needs than if I went to Sprouts, Fresh Market, or Natural Grocers. And yet, that larger size doesn't mean that Whole Foods is less profitable -- in fact, it's almost three times more profitable than the next largest competitor.

This isn't about wealth, it's about education
For well over a decade now, Whole Foods has been trying to shed itself of the "Whole Paycheck" moniker. Many pessimists now believe that since Whole Foods has expanded to as many wealthy, urban locations as it can, new stores simply won't draw as many visitors as they once had.

But those pessimists are confusing a wealthy clientele with an educated one. The link between these two variables is strong, but it isn't absolute. As one real estate developer who has worked with Whole Foods recently wrote :

Unlike the typical retailer, and contrary to what you might expect, Whole Foods does not focus on household income but rather on education levels in a potential trade area. They usually require a minimum population of 200,000 with college educations. One of their brokers once told me, "Look, I don't care what the incomes are; show me there are enough people there with degrees." If you work at a nonprofit, a yoga studio, or in government, but still shop at Whole Foods, then you know that the Whole Foods customer is not defined by his or her salary. 

The key difference here, over the long run, is that this reduces Whole Foods' ceiling. If the company's growth were predicated solely on being able to attract more and more wealthy shoppers, it would end up being a zero-sum game: every dollar that one wealthy person has is another that a poorer person doesn't have. There can only be so many wealthy folks in America.

But wealth isn't the currency that Whole Foods trades on; education is. And unlike wealth, education isn't a zero-sum game. One student getting a college degree doesn't prevent another student from getting one, it just creates incentive for universities to grow -- or new schools to open. The point is: Whole Foods benefits from a more educated populace, and the move toward a more educated populace is a strong trend in America right now. The ceiling for the company is much higher with this education focus.

Why now is the right time to expand
Finally, some have suggested that Whole Foods' decision to vastly ramp up the opening of new stores is a sign of desperation. There's some truth to that sentiment, but it doesn't tell the whole story.

Historically, Whole Foods has taken the slow and steady pace to opening new locations. Not only did this allow the company to be sure that their stores were placed in the right neighborhoods, but it allowed them to expand without taking on debt, and without serious dings to the company's profits.

But the landscape has changed. While lower prices will help Whole Foods fend off Wal-Mart, Safeway, and Kroger, I believe Whole Foods' expansion plan has more to do with the upstart organic grocers that have broad ambitions.

Before these players let their expansion plans be known, nothing was forcing Whole Foods to expand at a quicker pace. But that time has now come, as Sprouts says it envisions 1,200 stores nationwide, Natural Grocers thinks there are 1,100 possible locations out there, and The Fresh Market believes it will one day preside over 500 locations.

But all of these companies have much smaller footprints, much less cash, and a debt load much higher -- relatively speaking -- than Whole Foods. What does this mean? Basically, that Whole Foods has the experience and balance sheet to be the first-mover in just about any market it wants -- and it intends on doing just that.

I'm all in
It's entirely possible that we're not done seeing the run on Whole Foods' stock. It could very well continue to fall in the coming months. But over the next decade, I have little doubt that today's price will look like a bargain in hindsight.

That's why I'm buying enough shares of Whole Foods -- once Motley Fool trading rules allow -- to bring the company up to a full 6% of my family's retirement fund.

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Read/Post Comments (23) | Recommend This Article (50)

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 May 15, 2014, at 10:18 AM, PRODOD wrote:

    Brian, the last time I checked "culture & vibe" were not financial metrics. WFM may or may not compete successfully with the likes of KR or WMT but it seems clear that they will be forced to do so at much lower margins. The current PE for WFM is 25 and even a slide to 20 would put WFM at a 25% premium to the competition. Now is not the time to be long WFM.

  • Report this Comment On May 15, 2014, at 10:23 AM, TMFCheesehead wrote:

    @PRODOD-

    Don't underestimate the power of "soft" variables. I always have to remind myself that these companies don't operate on our computers or the financial statements issued by the company. They operate in real life!

    As for the company being over-valued, I have a 10-year time-line here, so on May 15, 2024, let's check back in and see how WFM did against WMT and KR.

    Best,

    Brian Stoffel

  • Report this Comment On May 15, 2014, at 10:51 AM, PRODOD wrote:

    Brian, I'm not underestimating the quality of WFM (the company) or the shopping experience they provide. As I stated, they may or may not compete successfully over your 10 year investment horizon. But if you want to be long WFM I'm nearly certain that you should be looking to buy at a lower multiple. This is after all the 'grocery' business and even if WFM is a 'hall of fame' grocer there is no reason to believe that the stock will continue to trade at a PE that is more than twice the industry average. Moreover, if you intend to hold the stock for 10 years, you should probably wait to buy until they are closer to completing the current 140 store expansion ... why take the equity risk that WFM will have a misadventure in their largest expansion to date...?

  • Report this Comment On May 15, 2014, at 11:01 AM, nolitimere wrote:

    Excellent article.

  • Report this Comment On May 15, 2014, at 11:36 AM, jbobbett wrote:

    Wegmans (private) is a big competitor that beats WFM on your "soft" metrics. 3.7 overall, 88% approve CEO, 79% of employees recommend. I think that's the one WFM needs to worry about most from a customer experience and passion standpoint.

  • Report this Comment On May 15, 2014, at 12:02 PM, TMFCheesehead wrote:

    @jbobbett-

    Ah, Wegman's. I fondly remember the store from my short stint in upstate New York. You're right, that is a very fine grocer.

    The trouble is, it's tough to get a hold on how the company performs financially since we don't have access to their statements.

    You're right, however, to point them out as a more valid competitor.

    Brian Stoffel

  • Report this Comment On May 15, 2014, at 12:07 PM, Pfoolhart wrote:

    Great article.

    It's said that Warren Buffet's primary consideration is pricing power--the ability to be priced above the competition. Losing that at Whole Foods concerns me no end, especially given the low margins in that business to begin with. Also, I disagree that wealth is a zero-sum game; no more so than education; it is created endlessly by creativity and industry. I love your positives, and totally agree. Mackey's great book "Conscious Capitalism" led me to stock-investing and the Motley Fool to begin with (WFM was my first, both a Core Value and Best Buy Now at the time), so I hope you're right in your bullish perspective. Lately--alas, when the prices are so appetizing--I'm not so sure. I'm long, but sadly on hold.

    Thanks,

    Ken

    P.S. On a separate issue: Does LOYALTY have a role in investing? I love John Mackey's mission!

  • Report this Comment On May 15, 2014, at 12:50 PM, Origin97 wrote:

    Buy when there is blood in the street. And when opportunity knocks, you'd better answer the door.

    Just because Walmart sells "organic" and "natural", doesn't mean whole foods customers will switch. It only means Walmart shoppers will have a new option in food choices.

    People, like myself, who shop at whole foods, shop at Whole Foods because Whole Foods has a mission. Whole Foods is in the culture. They are not jumping on a bandwagon.

    Furthermore, Whole Foods is the veteran in the industry. Nobody knows the ideals and needs of food conscious people of the population than Whole Foods does.

    Just walk through a store.

    Also, whole foods has a house brand product that is of high quality, so you don't have to pay as much as people think they would.

    I will also be putting my money where my mouth is, and take advantage of the panic.

  • Report this Comment On May 15, 2014, at 1:16 PM, investingforone wrote:

    Yes, LOYALTY is important. Not only are customers loyal to WFM, but employees are. In the grocery business, WFM's empowered, happy employees are crucial to success. WFM's employees are all of that and more - they are educated and can tell you everything you want to know about every product in the store. "What did that cow eat before it was slaughtered?" "Do you have 100% whole wheat bread made here?" "Where is your cereal?" "It's on aisle 3, I'll take you there and show you where it is."

    And, finally, my favorite story. I'm at checkout counter, cashier asks: "How much was this lemon?" Me: "I have no idea - sorry, I didn't look." Cashier: "Oh, well, I'll just give it to you." Note -

    1. it would have cost more than the price of the lemon to wait while someone went to check the price.

    2. The cashier had the power to make a decision like that - didn't have to call the manager.

    This is brilliant employee relations AND profit-making behavior!

  • Report this Comment On May 15, 2014, at 7:42 PM, classic216 wrote:

    WFM deserves to trade at a premium to the competition. It's that kind of company. Buffett once said, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

  • Report this Comment On May 15, 2014, at 8:32 PM, sparksinchitown wrote:

    CEO is a on the board of directors of MF but the stores certainly appeal to certain segments of the population. If you drive a Prius or a Volvo, twice a week your heading off to WFM. Price means no thing to the WFM customers. Image and PCness are the drivers. If WFM stay in their natural environment (in chicago that means Lincoln Park and the burbs) and don't expand into "non Prius country" they will do well.

  • Report this Comment On May 16, 2014, at 1:49 AM, SuntanIronMan wrote:

    You need to update your vernacular. The Prius is practically mainstream at this point. The type of people you are referring to think the Prius is passe, lol. Maybe change it to "non Tesla country" or something like that.

  • Report this Comment On May 18, 2014, at 5:49 PM, awallejr wrote:

    Unfortunately for most people it is all about price. I am sure those living paycheck to paycheck wished they could afford the WFM experience, but it just isn't going to happen. WFM is probably running out of places to expand to. They simply don't deserve their PE multiple at this point. There is no reason why they can't continue as a viable company but the days of strong growth is probably over.

  • Report this Comment On May 18, 2014, at 9:43 PM, Salix wrote:

    This article and the comments are interesting. I too like WFM.

    How are the employees treated? Are they paid well, with benefits, insurance, and retirement plans?

  • Report this Comment On May 18, 2014, at 10:35 PM, phexac wrote:

    It is kind of amusing how TMF writers simultaneously name drop Buffer every chance they get and never talk about valuation. The message seems to always be, "This is a great company!!! Who cares about the price you pay for it!?"

    So WFM is great at 25 PE as it was great at 40, as it would be great at 60? You better be expecting the stock to go up 5x over your 10-year horizon, because 100% return will barely cover the 40% WFM lost as you guys group pumped it up to now.

    The bottom line is it's pretty hard to take a financial writer seriously when he ignores that valuation even exists.

  • Report this Comment On May 18, 2014, at 10:38 PM, DoctorLewis4 wrote:

    I live in an area that has a Trader Joe's down the street from a Whole Foods. You want sales per square foot? Trader Joe's easily doubles what Whole Foods pulls in. (and I'm sure would double the metric listed in this article) I only wish they were a public company. Why is Trader Joe's so busy? That's easy - price + limited but great products. Why does Whole Foods have an empty parking lot? That's also easy - overwhelming store that is just too expensive.

  • Report this Comment On May 18, 2014, at 11:38 PM, dstb wrote:

    "If the company's growth were predicated solely on being able to attract more and more wealthy shoppers, it would end up being a zero-sum game: every dollar that one wealthy person has is another that a poorer person doesn't have. There can only be so many wealthy folks in America."

    Strange comment to hear from MF. Capitalism is not a zero sum game. People getting richer does not make others poorer.

  • Report this Comment On May 19, 2014, at 12:29 AM, KKoleto wrote:

    Great story but there is really no moat around WFM.

    Groceries are a commodity and there is a lot of competition in WFM's niche.

    Not paying 13 bucks for a chicken, no way, no how!

  • Report this Comment On May 19, 2014, at 12:44 AM, DukeMontrose wrote:

    Thank you for the opportunity to contribute.

    Now I submit for all fools kind consideration my PERSONAL experience with WFM.

    My exposure to the new wave of healthy food goes back some 30 years when I lived in Colorado + became friends with the founders of Celestial Seasoning, one of whom, M. Siegel, is a board member to this day of WFM.

    Now live in Sarasota, Florida, a most promising area for the WFM "culture". I helped to get WFM a $1 million subsidy from the City of Sarasota nearly 10 years ago for a 300 bay garage across the entrance of our new store.

    Fully expected that that store will become a "hub" store for the region. But nothing happened. The competition moved in + now we have dozens of new natural food stores all over the region.

    Including Trader's Jack, brash, innovative + an ambiance second to none.

    Dear Fools, none of those stores threaten WFM.

    But I do believe management in Texas missed a big opportunity around here.

    A concern with our WFM store in Sarasota the what appears to me, rapid turner-over in"team-leaders" - managers + assistant managers.I live within walking distance + visit the store several times a week.

    Thus I became familiar with the internal controversy erupted about a year ago involving the coffee shop, surely a high margin op.That shop also has a rapid turnover of team members. I don't know exactly why = just have the feeling of a missed opportunity right there. Like creating personalized coffee mugs for frequent customers. Like English pubs, for example, foster loyalty with personalized beer mugs

    Dear fools, I submit this brief account without knowing if anything I touched upon has any bearing whatsoever on the price + value of WFM I But I hope I added a teensy bit of usefulness.

    Good investing to all fools!

  • Report this Comment On May 19, 2014, at 9:00 AM, TMFLomax wrote:

    "Don't underestimate the power of "soft" variables. I always have to remind myself that these companies don't operate on our computers or the financial statements issued by the company. They operate in real life!"

    Amen, Brian! This is an awesome article.

    Alyce

  • Report this Comment On May 19, 2014, at 9:41 AM, TMFCheesehead wrote:

    @dstb-

    Fair point. I think the overall message behind what I was getting at rings true, but you're right, neither is a zero-sum game.

    Brian Stoffel

  • Report this Comment On May 19, 2014, at 10:20 AM, ffbj wrote:

    Well researched and well written article. I am not a big fan of WF, though it is more of a value than previously, due to it's falling price.

  • Report this Comment On May 19, 2014, at 2:33 PM, Borisbmx wrote:

    Doesn't look like they are going to be able to grow top line or bottom line much to cover the valuation.

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