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Why Whole Foods Market’s Biggest Problem Is Wall Street

By Bob Ciura – May 12, 2015 at 9:00AM

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Whole Foods' stock sank 10% after earnings, but the problem was irrational expectations. The company is doing just fine.

Judging from its stock price movement alone after earnings, investors might naturally assume that Whole Foods Market (WFM) had a terrible quarter. The stock fell 10% after reporting earnings on May 6 and is now down 15% since the beginning of the year. With drops like these, one might think the company's financial health is at risk. But that's not the case; in fact, quite the opposite.

From a fundamentals perspective, there is absolutely nothing wrong with Whole Foods. The company grew revenue and earnings per share by double digit percentages last quarter on a year-over-year basis. And Whole Foods also announced a new strategy, in which it will open new stores that offer products at lower price points. This could dramatically expand Whole Foods' growth opportunities going forward.

It seems that Whole Foods' biggest problem is not its business, but rather the unrealistic expectations that were embedded in its valuation prior to its earnings release.

The growth story remains alive and well
Last quarter, Whole Foods grew total sales by 10%, to $3.65 billion. Comparable store sales, which measures sales at locations open at least one year, grew 3.6%. Earnings per share increased 14% year over year to $0.44 per share. Return on invested capital increased by 68 basis points to 15% last quarter.

Nevertheless, the stock tumbled after its report simply because Whole Foods missed expectations. Analysts expected $3.7 billion in total revenue, and more than 5% growth in comparable store sales.

It's a mistake to assume the stock's drop is because Whole Foods is doing poorly. The company's results set records for sales and earnings per share in the second quarter. The only thing wrong with Whole Foods is Wall Street's expectations. Prior to earnings, the stock traded close to 30 times earnings before its sell-off, which was irrational to begin with. After all, the grocery business is intensely competitive. And after brutal winter weather in the first quarter, it's easy to see why Whole Foods' results came in slightly below expectations.

New strategy is right on the money
Investors should be excited about Whole Foods' growth last quarter, regardless of the stock price reaction. Another item to be equally excited about is what the future holds. Along with its earnings report, Whole Foods unveiled a new initiative that co-CEO Walter Robb called "A new, uniquely branded store concept unlike anything that currently exists in the marketplace."

According to the company, these stores will offer the same high-quality experience at lower price points. The stores will feature a modern design, and utilize a smaller-store format. The small-store concept is nothing new, and has worked wonders for other retailers like Wal-Mart Stores, which previously had trouble penetrating urban areas. Many large cities simply can't offer the same kind of square footage that caters to supercenters and large grocery stores. But rather than miss out on these markets entirely, slimming down is a very good strategy.

Whole Foods is targeting a value-oriented approach to lure in cost-conscious consumers, such as millennials. This may rub some shareholders the wrong way, who might fear that this strategy would simply cannibalize Whole Foods' own customers and dilute the brand. But this is misguided thinking. Whole Foods is going after entirely new markets and customer groups. These are customers who either didn't have access to Whole Foods or couldn't afford to shop there.

Take advantage of Wall Street's irrationality
Whole Foods executed admirably in a tough, competitive environment last quarter. The stock fell, but that's not the company's fault. Investors should hold a company accountable for what it can control. That does not include the stock price.

Whole Foods was arguably too richly valued heading into earnings. Now, the stock trades closer to 25 times earnings, which is much more reasonable. Investors should look at the post-earnings crash as a buying opportunity, particularly since the company has an entirely new growth opportunity in front of it. Whole Foods is doing just fine.

John Mackey, co-CEO of Whole Foods Market, is a member of The Motley Fool's board of directors. Bob Ciura owns shares of Apple. The Motley Fool recommends Apple and Whole Foods Market. The Motley Fool owns shares of Apple and Whole Foods Market. 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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