The Grocery Industry: Investing Essentials

Looking to invest in food stocks? Read this before putting your hard-earned money down.

Aug 5, 2014 at 3:30PM

Though its tough to imagine a world without them, it wasn't until 1916 that the first fully self-service grocery store appeared -- a Piggly Wiggly located in Memphis, Tennessee.  The concept grew slowly after that, and it wasn't until World War II ended and suburban sprawl began that grocery stores became so ubiquitous.

Today, the vast majority of food that Americans consume is now bought at grocery stores.

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An early Piggly Wiggly store. Source: Groceteria. 

What is the grocery industry?

The grocery industry broadly includes any location where consumers can go to obtain foodstuffs that are later prepared at home. Typically, this meant perishable goods like meat, fish, fruits, and vegetables, as well as nonperishable goods that were either boxed or canned. Recently, however, many grocery stores have begun offering pre-cooked meals for purchase as well.

Over the last 40 years, it has also become commonplace for grocery stores to offer non-food items. Typically, these are items commonly used around the house -- like cleaning agents and personal hygiene products.

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A Safeway store built in 1962. Source: Caldorwards4, via Wikimedia Commons. 

Though there are thousands of small, independent grocery stores across the nation, when investors are talking about putting their money behind a company, they are typically referring to one of the major publicly traded entities that has a number of locations across either a region or the entire country. The two largest pure-play grocers in the country are Kroger and Safeway--which combined have over 4,000 locations nationwide.

How big is the grocery industry?

The sheer size of the industry is mind-boggling. According to the Food Marketing Institute, grocery stores brought in $620 billion in sales in 2013, with over 37,000 locations and 3.4 million employees.

In terms of individual players, no company has a bigger hand in the grocery business than Wal-Mart. Though food initially played a small role in Wal-Mart's business model, the company has greatly expanded its capacity to provide food to consumers. Today, one-in-four grocery purchases in the United States are made at a Wal-Mart.

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Target and Costco join Wal-Mart as a segment of the grocery business referred to as hypermarkets -- enormous stores that weren't initially focused on food, but because of their size and scale, are able to offer food for rock-bottom prices.

That has left traditional grocers in a pinch. It helps explain why Cerberus Capital Management -- a private equity firm -- has begun buying out major players like Safeway and a number of chains previously owned by SUPERVALU.

The only publicly traded traditional grocer to survive the onslaught of hypermarkets has been Kroger, which has gone on an acquisition spree over the past decade to increase its presence.

On the other end of the spectrum are grocers with a smaller footprint that focus on natural or organic goods. None is more prevalent that Whole Foods Market, which is closing in on 400 locations nationwide.

Though Whole Foods is valued at almost $14 billion, it's important to keeps its relatively small presence in perspective. Wal-Mart has nearly 4,200 domestic locations, and Kroger occupies over 2,500 sites.

How does the grocery industry work?

Two variables have become increasingly important within the industry. As you might expect, the first is price. All things being equal, the average consumer will buy food wherever it is the cheapest. That gives a distinct advantage to those grocers with the largest presence, as they can obtain more favorable pricing from their suppliers, and thus offer their food at lower prices than the competition.

Hypermarkets also have an extra advantage on price. They can offer razor-thin margins, but make more money in the long run because groceries are simply the carrot that gets shoppers to enter the store. Once there, the customer is more likely to make other non-food purchases that flow to the company's bottom line.

The other variable is the overall experience of shopping. Whole Foods took what many saw as an annoying weekly trip to get food and strove to make it more pleasant and educational. 

The physical setup of the store, the strategic use of lighting, aroma, and acoustics, and free health classes that draw in the community have proven a huge success. The perceived benefits of organic food took off, and the strategy has spawned similar approaches by several smaller players like Sprouts Farmers Market, The Fresh Market, and Natural Grocers by Vitamin Cottage.

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Whole Foods demonstrates the careful control over lighting, sound, and aroma. Source: Whole Foods Market.

What are the drivers of the grocery industry?

Grocery stores provide products whose demand will never disappear, and will reliably produce a steady stream of business no matter the economic climate. Whether times are tough or booming, people simply need food to survive.

That being said, the landscape has been going through a massive change in the past ten years. Hypermarkets are able to offer food for less than traditional grocers. That's because, for hypermarkets, groceries are just a way to get customers in the door. Once there, shoppers are more likely to buy other, non-food items that help the company's bottom line. 

Traditional grocers simply don't have that advantage.

When it comes to the growing field of natural and organic grocers, there's currently an arms race under way right now. Whole Foods, Sprouts Farmers Market, Natural Grocers, and The Fresh Market all have ambitious plans to expand their footprints many times over. The company that's able to do this the quickest--without sacrificing the quality of its food or shopping experience--will likely be a great investment in the coming decade.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Brian Stoffel owns shares of Whole Foods Market. The Motley Fool recommends Costco Wholesale, The Fresh Market, and Whole Foods Market. The Motley Fool owns shares of Costco Wholesale and 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.

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