Organic Food: Investing Essentials

A primer on the organic food industry.

Aug 7, 2014 at 12:00AM

Just putting food on the table can be a chore for so many. Because of this, farmers have focused on ways to get the cost of putting food on the table as low as possible. Some of the methods used, including chemicals, antibiotics and factory farming, have not always been in the best interest of the consumer nor the environment. Because of that, these methods haven't sat well with many consumers, which has given rise to the rapidly growing organic food industry. 

Organic Food Tomatoes

Organic tomatoes. Photo credit: Flickr user epSos.de.

What is organic food?

The organic food movement is actually a labeling term. It refers to the way food is grown and processed. Synthetic fertilizers and pesticides as well as sewage sludge and irradiation are not used to grow organic food crops, and seeds cannot be genetically engineered. Instead, organic food uses pesticides and fertilizers that are derived from natural sources. Meanwhile, organically certified livestock are raised in accordance with health and welfare standards. In addition to that, animals are not given antibiotics or growth hormones, but are given 100% organic food and have access to the outdoors. Organic farming practices encourage soil and water conservation as well as reducing pollution, and at its core, the practice of organic food production promotes sustainability and ecological balance and conserves biodiversity.

Usda Organic Food Seal

USDA organic food seal. Source: USDA. 

The U.S. Department of Agriculture, or USDA, has established an organic certification program that requires all foods desiring to be labeled organic to meet strict standards to be certified. There are actually three different organic labels. Foods that are 100% organic may use that phrase, however, the term "organic" actually includes foods that are at least 95% organic, so, as long as the food product is 95% organic, it can display the USDA's organic seal. Products that contain at least 70% organic ingredients may label that the product is "made with organic ingredients."

How big is the organic food industry?

According to the USDA, more than 25,000 farmers, ranchers, and other businesses produce products under the USDA organic certification program. Over $35 billion worth of products are sold through the U.S. organic retail market, up from just a billion dollars in sales in 1990. In 2010, about 4% of the U.S. food and beverage market was organic food sales, however, organic claimed 11% of all fruit and vegetable sales that year. Overall, about 81% of Americans have reported to have purchased organic food in the past. However, organic food buying is highly concentrated, as nearly half of all organic and natural food sales come from just 18% of customers.

The organic food industry is still an emerging industry in the U.S., and sales are expected to grow by 14% annually from 2013 to 2018. Most organic farms or businesses are small-scale operations or have been acquired and are now just part of a larger company. That limits the options for those seeking to invest directly in the organic food industry. That being said, the combination of growing consumer awareness and greater availability of organic products is driving growth, so investment options should increase over time.

How does the organic food industry work?

Because organic is a labeling term, it is a completely voluntary certification. Therefore, barriers to entry are not all that high. A producer first decides to adopt organic principles and then submits an application to be certified. From there, a certification agent reviews the application and verifies that the practices of the applicant comply with USDA organic food regulations. An inspector will conduct an on-site inspection of the applicant's operation to ensure these regulations are being met. If all guidelines are met, an organic certificate is given to the applicant. After that, the applicant must be re-certified each year to ensure it remains compliant with the organic food regulations. Because of this, theoretically, anyone with some land and capital could choose to join the organic food industry.  

What drives the organic food industry?

There are several drivers of the organic food industry. Early on, it was driven by those seeking a more environmentally responsible solution to food production. However, over time, organic food has won more followers. Americans are becoming increasingly concerned with how their food has been grown and processed, and the organic certification provides greater peace of mind that their food won't be harmful to their health. This awareness has been enhanced by the growth of organic-focused food stores like Whole Foods (NASDAQ:WFM), which has also increased the availability of organic foods.

Whole Foods Organic

That being said, the bulk of organic food buying comes from consumers fully dedicated to the process. One survey concluded that 46% of organic food purchases were made by those who were either "true believers" in the process or "enlightened environmentalists." There are two big reasons organic food buyers typically have a dedication to the process. Organic food isn't as readily available, and organic foods typically carry premium prices because of the added production costs.

However, as more producers get certified, and more stores carry organic products, organic food is becoming an easier option for everyday shoppers who want to rid their diets of pesticides and food additives. Because of this trend, in 2010, more than half of organic food sales were sold through mass-market retailers. The combination of more grocery stores carrying organic foods, when combined with the growth of natural food retailers, is helping make organic food more readily available to the masses.

Overall, the industry is growing fast as more Americans are choosing to increase their consumption of organic foods. Given that nearly half of all organic food sales are to just a small subset of the population, there is great potential for future growth in the industry as more Americans increase their spending on organically certified food products. That's a tremendous opportunity for investors, as increased market share from organic foods could yield growing profits in the years ahead.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Matt DiLallo has the following options: short August 2014 $50 puts on Whole Foods Market. The Motley Fool recommends 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.

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