by Lawrence Meyers | November 14, 2013 12:00 pm
Several big-name stocks are so outrageously overvalued right now that there is far more risk in holding them than in selling immediately. Whole Foods Market (WFM) is one such name.
This is not a call on the organic industry itself. It remains in a secular uptrend, and that should be the case for some time. In fact, the organic messaging is so powerful that regular grocers like Safeway (SWY), Kroger (KR), and even Target (TGT) are also carrying organic food.
This also isn’t a call on the health of the company itself from a macro standpoint.
But still, you should sell WFM stock right now if you own it — and there are three simply reasons why.
The first reason to sell WFM: quantitative easing. Looking at my own short list of stocks with valuations that are out of wack, I believe the Fed’s quantitative easing program plays at least some role in each stock’s froth.
First, a brief review for those who aren’t up to speed on QE and what it has done to the markets. The Fed is buying $85 billion of bonds each month, which pushes bond prices up and drives yields lower. As yields have cratered, investors have moved money out of the bond markets and into the stock markets.
That means stock prices — whether WFM or another name — are being driven higher by this artificially induced demand. From my perspective, a lot of that money is going into large-cap brand name stocks.
And that brings us to the second concern with WFM stock: Its valuation. The artificial demand from QE, coupled with slowing growth, puts WFM at an unreasonable premium.
Despite the general strength of the organic sector, fourth-quarter Whole Foods earnings showed a few holes in the model. Same-store sales increased just 5.9% — the worst rate all year. And revenue only increased 2% year-over-year, with earnings only up 7%.
While the slow growth was partially due to accounting quirks, there was more bad news. WFM also lowered sales forecasts for fiscal 2014 as pricing competition is coming from all directions, including from Costco (COST). So now we’re looking at 15% year-over-year earnings growth for fiscal 2014, and 18% year-over-year growth the year after that. Analysts see 18% growth annually over five years.
That means WFM stock is trading at 34 times 2014 earnings, with a growth rate of half that. Sure, I’d assign a slight premium because the company has a few bucks in cash per share, no debt and always generates good cash flow. But even then, a multiple of 23 or so puts us nowhere close to the stock’s $59 price tag.
Last but not least, competition is another big concern for WFM stock investors. Everyone jokes about Whole Foods being called “Whole Paycheck.” The company is the most expensive of its kind — and people notice that, particularly during a bad economy.
Privately held Trader Joe’s sells many of the same things Whole Foods carries. And with other grocers battling to reclaim market share, I’ve seen the same organic produce at Whole Foods selling for 15% to 35% less at other stores. And while I don’t see upstarts like Sprouts Farmer’s Market (SFM) — itself trading at 100x earnings — eating Whole Foods’ lunch anytime soon, it is nonetheless another competitor on the radar.
So WFM stock is overvalued, with the store itself is facing competition at every corner. And going back to the QE problem, there’s no way to tell for certain just how much capital is flowing into Whole Foods as a result. But sooner or later, QE will stop.
If Whole Foods continues to struggle, the downdraft from that reality could be even more serious.
As of this writing, Lawrence Meyers did not hold a position in any of the aforementioned securities.
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