Please ensure Javascript is enabled for purposes of website accessibility

Better Buy: Whole Foods Market, Inc. vs. Costco

By Daniel Sparks - Apr 20, 2016 at 6:46PM

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Both are great businesses, but one is trading at a discount.

For the most part, grocery companies are both slow growing and boring. But then there's Costco (COST -0.71%) and Whole Foods (WFM) -- two clear leaders in their respective niches and both continually challenging norms accepted by competitors. However, no matter how "hot" these companies might be, is the value in their stock price compelling? To aid in an analysis of these stocks' investment prospects, here's a head-to-head comparison of the two companies:

Metric

Costco

Whole Foods Market

Trailing-12-Month Revenue Growth (YOY)

1.4%

6.3%

Trailing-12-Month EPS Growth (YOY)

2%

(7%)

5-Year EPS CAGR

12.9%

15.7%

P/E

28.7

21

Costco
The greatest facet of Costco as an investment is the company's durability. Over the years, Costco has grown in size and flexed its industry-leading scale as a competitive advantage. Known for its operational efficiency and its astute execution, Costco is consistently able to deliver leading value for its wholesale members while simultaneously growing profits for shareholders despite its competitive merchandise pricing.

This discipline in operational efficiency and capital allocation, paired with the company's scale advantage, has helped drive outsized growth in earnings per share compared to revenue growth over the past five years.

COST Normalized Diluted EPS (TTM) Chart

COST Normalized Diluted EPS (TTM) data by YCharts.

Costco's EPS has increased an average of about 13% annually over the last five years on approximately 8% annual revenue growth. But investors will have to pay a steep premium to buy this excellent business. Costco trades at nearly 29 times earnings.

Whole Foods
When it comes to stores that offer only natural and organic food, Whole Foods is the market leader by a long shot. Indeed, Whole Foods' lead on other organic grocery stores is so significant that it could be compared to Costco's dominance of Wal-Mart's Sam's Club. In other words, there is no clear second to Whole Foods' dominance in the organic grocer space today.

Image source: Whole Foods.

Unlike Costco, however, Whole Foods has faced challenges growing its EPS in line with revenue. Heightened competition as Kroger and Costco ramp up their organic and natural offerings has pressured the company's premium prices. As competition continues to heat up, investors are concerned the company won't be able to sustain its impressive 3.4% net margin. And investors are probably right; this net margin will almost certainly come down.

But worries about competition have helped create a buying opportunity. The stock is down 36% during the past twelve months and the stock's price-to-earnings ratio of 21 is fairly low when viewed next to the company's growth and its long-term prospects. Over the long haul, the company's comparatively faster revenue growth than Costco's should help Whole Foods return to EPS growth -- even if its net margin is pressured.

If management is right about Whole Foods' growth potential, there's significant runway ahead. Whole Foods currently has just over 400 stores. But management believes there's potential to nearly triple this store count -- and this doesn't even include its new 365-branded store format, which the company had already signed five leases for when it reported first-quarter results earlier this year.

Investors who buy amid these challenging times for Whole Foods -- and before it returns to its historical precedent of prudent capital allocation and EPS growth -- could see market-beating returns.

In light of its more conservative valuation, I think Whole Foods stock is a better buy than Costco.

Invest Smarter with The Motley Fool

Join Over 1 Million Premium Members Receiving…

  • New Stock Picks Each Month
  • Detailed Analysis of Companies
  • Model Portfolios
  • Live Streaming During Market Hours
  • And Much More
Get Started Now

Stocks Mentioned

Whole Foods Market, Inc. Stock Quote
Whole Foods Market, Inc.
WFM
Costco Wholesale Corporation Stock Quote
Costco Wholesale Corporation
COST
$434.60 (-0.71%) $-3.12

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

Related Articles

Motley Fool Returns

Motley Fool Stock Advisor

Market-beating stocks from our award-winning service.

Stock Advisor Returns
322%
 
S&P 500 Returns
116%

Calculated by average return of all stock recommendations since inception of the Stock Advisor service in February of 2002. Returns as of 05/25/2022.

Discounted offers are only available to new members. Stock Advisor list price is $199 per year.

Premium Investing Services

Invest better with The Motley Fool. Get stock recommendations, portfolio guidance, and more from The Motley Fool's premium services.