Grocery Store stocks: why are P/E ratios so high?

I want to create 3 statement, comparable company, and DCF models for a well known grocery store/supermarket chain. My ultimate goal is to use the analysis to create a solid stock pitch for interviews. I've identified a few stocks that analysts are bullish on, but they all have high P/E ratios: Harris Teeter (19.62), Kroger (21.08), Whole Foods (42.44), Fresh Market (46.43).

How can analysts be bullish on stocks with P/E ratios above 40? I'm leaning towards either Kroger or Harris Teeter--will I have a hard time pitching the stock to an interviewer if the P/E is above 20 or is this standard for the industry?

Comments (15)

 
Best Response
Sep 10, 2012 - 7:49pm

Companies like Whole Foods provide more opportunity to grow versus companies like Kroger. There is a reason why the market assigns them a low P/E because they are dog shit compared to their competitors. You should think of these stocks from a timing point of view rather then buy and hold. Where is the best opportunity to enter this stock and where should I exit. You might think its "safer" to invest in a low P/E stock but you still have the same chance of loosing money. Don't be afraid of high P/E simply because it is high. Look at it from a forward basis using your own estimates and you'll might discover its actually trading at a discount to expectations.

 
Sep 15, 2012 - 11:01am

bearing:
Companies like Whole Foods provide more opportunity to grow versus companies like Kroger. There is a reason why the market assigns them a low P/E because they are dog shit compared to their competitors.

Could you please expand on this a little more?

 
Sep 15, 2012 - 3:44pm

<span><a href=//www.wallstreetoasis.com/company/goldman-sachs><abbr title=Goldman Sachs>GS</abbr></a></span>:
bearing:
Companies like Whole Foods provide more opportunity to grow versus companies like Kroger. There is a reason why the market assigns them a low P/E because they are dog shit compared to their competitors.

Could you please expand on this a little more?


I don't follow the supermarket industry but I see P/E as the grade the market assigns to a company. On relative terms, if the companies are comparable then there is a reason that the company is trading at a lower multiple to its competitors. My natural assumption is that the company has either lower growth opportunities, poorly run etc, since something must be depressing those expectations. Ovechkin is correct that P/E is grounded on fundamentals but it's OP job to look at that. High P/E should not dissuade you from investing in a stock. It's a lazy call and precludes you from many money making opportunities.
 
Sep 10, 2012 - 9:30pm

You can pitch any one of the stocks you mentioned and make a strong impression, as long as your reasoning is sound and the interviewer can understand your thought process.

For example, you could pitch Kroger as a well-established pure-play (although they're diversifying away from that now) in the grocery space with consistently growing comp store sales. Or you could pitch Whole Foods as the leader in a rapidly-growing natural foods grocery store segment, with expected comp store sales growth and potential for increased top line growth through the opening of new stores in the future. As long as your assumptions make sense to the interviewer and they justify the valuation, then a high P/E probably isn't going to get you in trouble.

 
Sep 15, 2012 - 9:56am

pdxshortseller:
You can pitch any one of the stocks you mentioned and make a strong impression, as long as your reasoning is sound and the interviewer can understand your thought process.

For example, you could pitch Kroger as a well-established pure-play (although they're diversifying away from that now) in the grocery space with consistently growing comp store sales. Or you could pitch Whole Foods as the leader in a rapidly-growing natural foods grocery store segment, with expected comp store sales growth and potential for increased top line growth through the opening of new stores in the future. As long as your assumptions make sense to the interviewer and they justify the valuation, then a high P/E probably isn't going to get you in trouble.

Thanks--this is helpful

 
Sep 11, 2012 - 3:37pm

TESCO: world's third largest food retailer trading with a P/E of 8.5x
WMT: world's largest retailer and dominant food retailer trading with a P/E of 15.61

There are cheap food retailers out there...

 
Sep 15, 2012 - 2:57pm

Read up on justified P/E multiples. All multiples are based on fundamentals, something that a lot of relative value players seem to ignore.

 
Sep 16, 2012 - 9:18pm

I think you should calculate the betas of the companies and then you could look at the WACC. Supermarkets generally have a very low beta because they usually have stable CF and aren't cyclical like a lot of other industries are. The fact that the beta is so low = WACC that will be low. This leads to a higher P/E

 
Nov 25, 2015 - 3:22am

P/E is a borderline useless metric because it ignores capital structure. A highly levered company will often look "cheap" while a totally unlevered or net cash company will look expensive according to P/E. Also, with retailers especially, you need to consider whether the retailer is leasing its stores or owns them. A retailer that owns its stores will again look expensive according to P/E, while a retailer that leases everything looks cheap.

 
Nov 25, 2015 - 3:35am
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