Better Buy: Whole Foods Market, Inc. vs. Wal-Mart

Whole Foods (NASDAQ: WFM) and Wal-Mart (NYSE: WMT) cater to different shopper demographics, but their shareholders have one thing in common right now: They're significantly trailing the market.

Wal-Mart is down 20% over the past year even as rival Target (NYSE: TGT) is up 1%. Whole Foods' stock has slumped 28%, compared to a 1% uptick for competitor Kroger (NYSE: KR).

So today I'm stacking the two unloved retailers against each other to find out which one might make the better buy for investors shopping for a discounted stock.

Whole Foods vs. Wal-Mart: Key investing stats

Sales growth is for existing locations in U.S. stores. Data source: Company financial filings and S&P Global Market Intelligence.

Many things separate the two companies' operations, including their size and scale ($11 billion vs. $200 billion market caps) and their retailing approach (low-cost leader vs. high-end servicer). In addition, unlike Whole Foods, Wal-Mart has a huge international presence and gets a significant chunk of revenue from consumer products like electronics and apparel.

But at their core, they are retailers that have fallen on unusually tough times. In their last fiscal year, Wal-Mart's profits sunk 11% as Whole Foods' comps were just 2.5%, compared to 7% in fiscal 2013.

Pick a turnaround plan
An investment in either business is a bet that things will eventually improve. In Wal-Mart's case, executives' plan calls for huge spending in two key categories: e-commerce and the customer experience. The company is pouring billions into upgrading its online fulfilment infrastructure and launching new initiatives like grocery delivery. Rival Target recently demonstrated that traditional sellers can succeed online (e-commerce sales spiked 34% over the holidays compared to Wal-Mart's 8%), given the right strategy, and the retailing titan hopes it can post similar growth.

Image source: Wal-Mart.

As for the in-store experience, Wal-Mart is busy raising its customer satisfaction scores through boosting its employee wages and developing cleaner, better stocked locations. The idea is that the major profit pinch now will lead to sustainable long-term growth. In any case, with $27 billion of annual operating cash flow, few companies can match Wal-Mart's ability to aim resources at a problem.

Image source: Whole Foods.

Whole Foods also has an expensive answer to its core challenge: an entirely new store concept. Low-cost rivals like Kroger have siphoned off market share in the organic food sector by slashing prices.

Here, Whole Foods' 35% gross profit margin is actually a liability since Kroger can use its 22% margin to undercut the market leader.

Whole Foods' answer involves developing a new store footprint that has a lower cost profile that makes it possible to compete on the basis of price without sacrificing the brand's premium cache with shoppers.

The better buy
In both cases, investors are being offered a discount for the risk involved in a business that needs to execute a turnaround. Whole Foods' price-to-earnings multiple is down to 22 from over 40 in 2013 and Wal-Mart can be purchased at 0.45 times revenue, compared to 0.6 times through most of the past two years. Conservative investors would likely prefer a Wal-Mart purchase, though, given its dominate market position, formidable balance sheet, and hefty capital return program.

Yes, Whole Foods has a bigger hill to climb, given that its core business has to adapt to the twin challenges of online selling and pricing pressures. But shareholders also stand to gain more from this stock because as organic groceries move mainstream, Whole Foods' addressable market expands in a big way. That's why my view is that the grocery chain should be in a stronger position in a few years, and patient investors are likely to see better long-term returns from here.