Two decades ago, investors scoffed at the idea that people would pay a premium to buy food that was certified organic. "They simply don't care," the naysayers quipped. But Whole Foods Market (NASDAQ: WFM ) co-founder and co-CEO John Mackey knew better.
Between the depths of the Great Recession and last October, investors who bet on Mackey's strategy were sitting on an unbelievable return of 1,560%. Since last October, however, fortunes haven't been nearly as good, with shares losing 40% of their value.
Much has been made recently about new entrants into the organic/natural food space in America. While Sprouts Farmers Market (NASDAQ: SFM ) , The Fresh Market (NASDAQ: TFM ) , and Natural Grocers by Vitamin Cottage (NYSE: NGVC ) attempt to use Whole Foods' blueprint, Wal-Mart (NYSE: WMT ) is teaming up with Wild Oats to offer more organic goods in its discount stores.
However, while those developments do warrant caution on the part of investors, there are still many reasons to believe Whole Foods' stock has better days ahead. Here are three reasons Whole Foods stock could rise.
The organic movement's sustainable growth
It would be easy to assume that the growth of organics will soon reach a saturation point. Sales of organic goods between 2000 and 2012 delivered an annual growth rate of 13.5%. That's a torrid pace!
However, as of 2012, organic food sales, though they had grown rapidly, accounted for less than 5% of all food purchases in the United States.
That means there's still tons of room for growth. This is particularly true for fruits, vegetables, dairy products, and meats, all of which are particularly popular among purchasers of organic goods.
Pricing the competition out
Part of the reason investors have been so worried about Whole Foods' prospects has to do with shrinking margins. As I've shown before, Whole Foods enjoys margins that are the envy of the industry.
Management has said for a number of quarters now that it is "investing in price." That's industry speak for "selling food for lower prices." Obviously -- all things being equal -- that means Whole Foods' profit will come down.
But that's a short-term view, and all things are not equal. While Wal-Mart could likely compete on the price of some goods, its customer base is distinctly different than Whole Foods'. Instead, I think Sprouts, Natural Grocers, and other upstarts will find it increasingly difficult to beat Whole Foods on price and/or selection. Over the long run, that means Whole Foods grabs more share of what is -- this is the key-- a rapidly growing market.
So even if margins come down, volume should take off in the long run.
For a long time, Whole Foods stated that its goal was to establish 1,000 stores stateside. But last December that number was upped to 1,200. (It currently has 388 stores.) More important, however, was the recent announcement that the pace of expansion would pick up rapidly.
Whole Foods already has far more locations than its closest pure-play competition.
When you combine its pricing power, the larger selection that Whole Foods offers, and the fact that it has a large and expanding footprint across the country, the company has a great chance to gain an increasing share in the ever-expanding market for natural and organic foods.
The takeaway for investors
It will take a while for Whole Foods' lower prices to filter down to everyday consumers. Investors shouldn't expect an immediate turnaround in the stock price.
Long-term investors, though, should have no problem waiting to see how this story plays out. If things go according to plan, there's a good chance they'll be rewarded for their patience.
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One part of an investment in Whole Foods is also the expectation that once it reaches 1,200 stores, it will start paying a sizable dividend. The smartest investors know that dividend stocks simply crush their non-dividend-paying counterparts over the long term. That's beyond dispute.
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