I love owning Whole Foods. It is a great example of a Rule #1 company.
First, Rule #1 investors don’t buy stock. We buy businesses. That means we evaluate the opportunity as if we owned the whole thing and as if there was no stock market for the next ten years.
Second, Rule #1 investors try to buy $1 of value but only pay $0.50 for it. When we do this correctly we know we are going to make money at some point. We also know that our risk is less than if we bought a comparable business but paid the full $1 for it. We call this a Margin of Safety. I insist on a MOS because I’m not all that smart and need a cushion that can absorb my mistakes in valuing a business or unexpected problems that the business might have.
For those two reasons, we have to put a value on a business before we can buy it. Valuing a business the way we do it with Rule #1 is all about predictability. Predictability comes from consistency and consistency comes from some form of monopoly. Without getting into this in detail, and getting back to Whole Foods, WFMI has a monopoly in the natural foods business and a growing monopoly in the high end grocery business and has a management team that produces consistent growth in cash, earnings and equity. In my view WFMI and Wal-Mart are going to crush the old school grocery stores between them; WFMI from the top, WMT from the bottom. As a business owner, that’s the kind of market clout that I’m looking for to predict the future with some degree of certainty. In other words, because of its growing monopoly it looks like WFMI should be able to continue doing for the next ten years what its been doing for the last ten years.
So what has it been doing for the last ten years? It been doubling EPS every two years. Over 40% per year. Its been doubling equity every three years. Over 26% per year. Same with cash. It can pay off its debt in 6 months. ROE is at 14%, ROIC is at 11%. Those numbers scream ‘PREDICTABILITY’!!!
So how to value it? The minimum return on our money that we’ll accept is 15% per year. To get to the correct current value for WFMI we just estimate future growth based on past growth and apply the 15% minimum to get a current retail price – which I call Sticker Price. Here’s the calculation on an excel spreadsheet:
1. current ttm eps: 2.32
2. past growth rate: 26%-40%. Zacks avg. is 20%. Use 22%
3. est. future PE: 44 (double eps growth but not more than 50)
4. EPS in 2015 =fv(22%, 10 yrs, $2.32). $17 per share
5. Value per share in 2015 = $17*44 $746 per share
6. Sticker Price =pv(15%, 10, $746) $184 per share
7. MOS Price = Sticker / 2 $92 per share
8. Actual Price per share Feb 4, 05 $90 per share
The Sticker Price is the price that will get me a 15% return for the next ten years if everything goes as the analysts think it will. Since on Feb 4, Sticker is about 100% above MOS, I’m in a great situation. I like the fact that the company’s actual results significantly exceed the my projection. If a lot goes right, and it could, this company could rule the grocery world in a few years. A growth rate at their low end average of 26% would put the Sticker Price today at $290 a share. That makes me feel like my MOS probably has more cushion than it looks like.
That’s good because I bought Whole Foods at $90 today.
That said, WFMI is trading at a huge multiple. It wouldn’t take much bad news for it to pull back to 70. So, at least those of you who are using tools, watch the arrows, watch the big guys and don’t hesitate to go to cash when the money runs the other way. You can always get back in when they return.
Now go play!