Much as the dot-com stocks flourished in anticipation and curiosity, Whole Foods Market (WFM) thrives in its benevolent esteem. A highly reputed company will generally become fully valued, but when the reputation is rooted in emotions rather than logic, its price can become truly overgrown. Since 2008, WFM's market price has increased over 13 fold to a whopping $97.22, which represents a significant premium to competitors such as Roundy's (RNDY) and Wal-Mart (WMT).
Price to 2013 expected earnings ratio
Price to book ratio
Market price $
Whole Foods Market
While these metrics clearly show that Whole Foods is overvalued relative to its peers, it is fairly common for valuation disparities of this magnitude to exist. So, what is it that makes Whole Foods a unique short opportunity? Both the company's and stock's performance are deeply entrenched in the fragile and unproven concept of the environmental and nutritional superiority of their products.
A recent meta-analysis from Stanford University concluded that there is no evidence to suggest that organic food is healthier than its counterpart. This research was summarized in the New York Times, linked here. Additionally, the study concluded that organic food is equally likely to be contaminated. This is evidenced by the staggering list of food recalls issued by Whole Foods linked here. With no evidence of organic food being healthier, WFM is relying on a consumer base consisting of those who are willing to pay extra for moral reasons and those who perceive some health benefit.
There is certainly something to be said for not using pesticides and humanely treating animals. One could reasonably say this approach is healthier for the environment and simply the right thing to do. While this is largely agreed upon, it becomes a matter of how much consumers are willing to pay for it. In strong economies WFM has no problem finding people willing to pay its higher prices, but during downturns shopping at Aldi's or Wal-Mart instead of WFM is one of the easiest ways for consumers to stay ahead. As evidence, Whole Foods was forced to stop paying their dividend during the crash of 08 and the stock fell into the $8 range. People want to support environmentally conscious companies, but in times of crisis this becomes a very low priority.
WFM's ability to continue charging premium prices in times of recession seems very shaky. It should be noted that Whole Foods does not sell exclusively organic food, but its superior selection of organics is a large portion of how the higher prices are justified.
One thing I do admire about Whole Foods is its ability to create alignment of management with shareholders inexpensively through the use of stock options. Here is the compensation schedule of the top officers according to Yahoo Finance.
John P. Mackey
Co-founder & Co-CEO
A. C. Gallo
President & COO
CFO& Exec VP
The other effect of having payment so heavily weighted as stock options, is that it gives us a good idea as to how management values the company. It seems most of the officers have been selling virtually all of their shares of WFM, evidenced here. Many even did so back when it was priced in the $40-$50 range. The exception to this behavior is John Mackey, who retains 964,558 shares as of August 30. While I cannot know his reasoning, my guess is that as one of the founders of the company he truly believes in it.
So, with a stock trading at an exceptionally high earning multiple and sentimentally driven operations, I believe that shorting WFM would provide a nice hedge against an economic downturn. Allow me to further explain the reasoning here.
Shorts are always going to be risky plays, but a short of Whole Foods has three factors which reduce the associated risk.
1) Its current valuation provides some hindrance to further price increases.
2) The very small dividend makes it possible to hold onto a short position longer without being so costly.
3) Wal-Mart and other food suppliers are making a point to offer more organic products, so any increase in demand for such food will be partially absorbed by other lower cost suppliers.
The benefit of such a short is that WFM's stock performance has been closely linked with the economy, both historically and by the reasoning above, so a downturn may make the short very profitable, thus mitigating the losses from other positions. This may be a good play to consider for hedging a portfolio that is heavily banking on continued economic recovery. As always, it is highly recommended that you do your own research before investing, especially when it comes to shorts.
Disclosure: This article is for informational purposes only. It is not a recommendation to buy or sell any security and is strictly the opinion of the author.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.