Looking Beyond the P/E
Stephen is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
On 11 July 2011, I made what may be one of my dumbest CAPS calls: I predicted that Whole Foods Market (NASDAQ: WFM) would underperform the market. I won't say it was a bad call based on the fact that Whole Foods has since outperformed by 34%. I will say it was a bad call because it was based on one simple metric: the P/E.
What is Overpriced?
For many of us, the P/E is the first metric we learn about in stock investing. It's our first opportunity to feel intelligent about investing, to use the lingo. We rely on it, we love it! Sometimes you can be blinded by love, and I ignored every other piece of conventional wisdom about investing when I decided Whole Foods was overpriced in July 2011 because it's P/E was around 34. To conclude, this meant Whole Foods was overpriced, I compared this to the P/E of other supermarket companies: The Kroger Co. (NYSE: KR), and Safeway Inc. (NYSE: SWY).
My thorough analysis ended there. Overpriced, right?
Maybe I'll Take Another Look
"If you stay half-alert, you can pick the spectacular performers right from your place of business or out of the neighborhood shopping mall.." - Peter Lynch from One Up on Wall Street
In my case, I wasn't half-alert every Sunday morning when my wife and I buy groceries at Whole Foods. Yep, I shop there! I have firsthand knowledge of how expensive it is, how busy it always seems to be, the type of people who shop there, and the quailty of the shopping experience. I know that several years ago I never heard of the company and how it's a household name today. The market research I had unknowingly conducted on Whole Foods over the years would have pointed towards a strong company still at the early stages of a great growth story. Instead, I chose to rely on a metric over personal experience.
Another good idea would have been to compare these companies using some other metrics. Here's a quick table I put together using the most recent filings that would have been available to me in July 2011.
It's starting to become clear why Whole Foods was trading at a higher premium than Kroger and Safeway. To be honest I really didn't even need to refer to the filings. It's fairly intuitive to think Whole Foods would have higher margins and stronger growth rates than Kroger and Safeway. It's not even entirely fair to compare these companies as apples to apples. Whole Foods caters to a customer base with more disposable income and who place a premium on the quality and ethicality of their food. Over the last year I've heard or read dozens of stories detailing the continued success of higher-end retail despite the poor economy. It stood to reason Whole Foods would fall in this category as well.
I'm not going to beat myself up over making a CAPS call that turned out wrong. That's one of the things I love about CAPS. It's an easy tool to test out investing ideas and strategies without risk. I use CAPS to gauge the reliability of some stock screens I come up with, to test 'word of mouth' investing ideas, and sometimes to simply judge a stock based on a single metric like the P/E. What's important is that I periodically review the performance of my selections and look for lessons to be learned from my failures and successes. My CAPS call for Whole Foods taught me to look beyond the P/E ratio.
Have you made an investing decision based on a single metric or piece of information? Did it bite you in the end or did it pay off big? Leave a comment below.
drfrank1 holds no positions in any of the stocks discussed in this article.