June 10 was a rough day for Whole Foods
UBS Securities drove the day's drop. The firm downgraded Whole Foods from "neutral" to "reduce" because -- in UBS's opinion -- the price was outpacing the company's value. UBS wrote, "We think the current share price discounts long-term growth at levels which leave no room for failure, and we feel uncomfortable moving our price target any higher."
Fair enough. Whole Foods' stock trades at hefty multiples -- including a P/E ratio north of 50 -- that dwarf competitors such as Safeway
This argument sounds a lot like the one Fool co-founder Tom Gardner cited when he sold twice-recommended Whole Foods from his Motley Fool Stock Advisor portfolio in May 2003. In his flash to subscribers at the time, Tom wrote, "Today, Whole Foods is trading north of $60, and I'm recommending that you sell the stock, based on valuation. I do not believe that the business has gotten weaker. In fact, it's grown stronger . I simply believe the stock is overvalued."
As usual, Tom saw the writing on the wall long before the folks on the Street did. Unfortunately, that foresight cost Tom a double this time, instead of earning him one.
A Rule Breaker rule-follower
I purchased Whole Foods for a very Peter Lynch-esque reason: I knew the product well, loved it, and saw more people shopping each week at my local Whole Foods. The stock was trading for approximately $45 at the time, and I heard the same dichotomy:
- Whole Foods is a superior company.
- Whole Foods is overvalued.
I can't dispute that, in a conservative discounted cash flow (DCF) evaluation, Whole Foods is overvalued by a long shot. But I'm still holding my Whole Foods shares, based on some of David Gardner's Rule Breaker criteria:
- Top firm in an emerging industry
- Sustainable advantage gained through momentum and visionary leadership
- Strong past price appreciation
- Good management
- Strong consumer appeal
- Called overvalued by the financial media
Under CEO John Mackey's leadership, Whole Foods has made the "crunchy" business of natural foods into a profitable phenomenon, silencing competitors such as Wild Oats
Whole Foods aims for $10 billion in sales by 2010. The company's current net profit margin is 4.3%, but I expect that to rise to 5% as Whole Foods realizes further efficiencies. If the company hits its sales target in 2010, net earnings will come in at approximately $500 million. That's a compounded annual growth rate of 25%: high, but not unrealistic given the results Whole Foods has been posting.
Account for 4% annual dilution, and Whole Foods' EPS in 2010 could come in around $6.33. By that time, the company's P/E multiple will have come down, but I expect it to stay above the industry average. In all, I'm holding a company that I believe could be worth $200 per share or more in 2010.
Although the above scenario is a bit of a shot in the dark, this Fool feels comfortable owning part of a well-managed company that is widely recognized as a class-A operation. With so many lesser companies trading on the market, why let a good one go?
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