Why Pay Such a Premium for this Stock?

When I look at charts, I like seeing stocks that show a nice steady uptrend. A company that has been firing on all cylinders and has returned some impressive gains for shareholders is Whole Foods Market Inc. (NASDAQ/WFMI) — the country’s largest chain of natural and organic foods with 170 stores in the United States, Canada, and the United Kingdom.

 Since debuting on January 23, 2002 at an adjusted close price of $6.03, the stock has been on fire on the chart, recently trading at $152.67 on November 3. That’s a gain of 2,432%!

 During that period, Whole Foods has easily outperformed the DOW, S&P 500, and NASDAQ by a wide margin. The breakaway on the chart occurred in 2001 when the demand for a healthier lifestyle drove shoppers to Whole Foods.

 It is not difficult to understand why shoppers like buying their food at Whole Foods. The typical outlet is massive, and you can find just about anything you’d want — including natural beer. My wife loves the place and does as much shopping there as possible, not minding paying a premium for natural and organic foods, and many other shoppers seem to have the same idea.

 While the concept is great, I really wonder why the market would assign such a premium for the stock. Trading at 43.52 times its estimated FY07 EPS (ending September 207) and a PEG of 2.46, the stock is not cheap. In fact, the valuation is not even reasonable, unless the company can deliver some mind-blowing numbers. So far, this has not occurred.

 The company is highly profitable, but its performance versus Wall Street has been anything but stellar. In the recent Q4, Whole Foods reported a shortfall in its earnings by 5.7%, or $0.03 per share, yet the stock still holds. Prior to that, the average the company has beaten EPS estimates for the previous three quarters is a mere 4%. That is not what I want to see in a stock that is assigned such a large growth premium.

 As far as Wall Street is concerned, the company’s earnings have seen a downward revision in its FY07 on five occasions during the last 90 days.

 So, while I like Whole Foods as a place to buy healthy foods, I really cannot understand why anyone would pay such a premium for the stock. Now I could be wrong, but if you do hold the stock, I advise you have a solid stop-loss in place or purchase put options to hedge the downside risk.