Business Environment
Whole Foods is the world’s leader in natural and organic foods with more than 270 stores in the United States, Canada, and the U.K. This continually expanding company got their start in Austin, Texas in 1980 as a natural food grocery store. In the past 28 years they have rapidly expanded through acquisitions and new store openings. They have risen to success with their combined concentration on high quality products, unique shopping experience, distinctive corporate culture, and environmental focus. More recently, they started a line of private branded grocery products sold exclusively in their stores. Whole Foods currently employs 54,000 employees worldwide. They have nine distribution centers and are located in 37 U.S. States.
Macroeconomic Analysis
The United States economy has been highly volatile in various markets over the past few years and currently is affecting the way the retail industry has been conducting business. The Bureau of Economic Analysis of the United States Department of Commerce reports that August GDP rose 3.3% from the first quarter to the second quarter of 2008. They also state that Gross National Product rose 2.2% from the first quarter to the second quarter. Personal Income decreased $89.9 Billion, or .7%, from June to July 2008. The reported unemployment rate also jumped from August 2008 to September 2008 from 5.7% to 6.1%. Factors most likely affecting such significant changes could be sharp increases in oil prices over the summer months, the increasing inflation, and the struggling financial markets. The value of the dollar has fallen in recent months. Consumer behavior has been an affected by the current economic conditions. Americans will most likely not be able to afford the same lifestyles they had previously enjoyed. The consumers whose income remains stagnant against the increasing prices will most likely reduce their spending habits because of this. In May of 2008 the U.S. government implemented an economic stimulus package in order to increase consumer spending and encourage economic growth. Figure 1.2 displays the result of the package on real personal disposable income. The strategy proved to be a temporary fix as, by July, numbers had settled back down to previous levels. Because disposable income is not increasing, current spending habits are likely to harm the retail industry’s revenues this year, especially the retailers of higher end goods. Although Whole Food’s attempts to keep prices competitive with traditional grocery stores, because of the economic trends mentioned, there is a much smaller market for their products.

According to the annual report that Whole Foods released for 2007, a large percentage of their cost of goods sold is determined by agricultural prices. The Annual Stakeholder’s Report from 2007 states that 67% of their revenue is generated from perishable products. They also affirm that the majority of their purchases come from local and national levels. For this reason, they are heavily influenced by the economic trends impacting food prices. According to the Bureau of Labor Statistic’s Consumer Price Index Summary Report, the unadjusted 12-month food and beverage rate is reported at 5.9% growth rate over August 2007. Among the largest increases in food prices, fruit and vegetables were up 2.1% in August following a 1.2% increase in July. The only category that showed a decrease was cereal and bakery products, which fell .1%. The dramatic swell in fresh produce costs will definitely have a direct effect on Whole Food’s annual net income for 2008. From 2006 to 2007 their net income fell from 204.1 million to 182.84 million, a 10% drop, and already in 2008, Whole Foods has experienced a large decrease in net income. Operating expenses also increased 18.91% from 2006 to 2007. Since a large percentage of their sales come from the fruit and vegetable category, Whole Foods may have to restructure their marketing strategy to increase sales of non-perishable goods.
In 2007 Whole Foods expanded greatly through opening 21 new stores and through a merger with Wild Oats Markets, which gave them 109 new stores. In their 2007 annual report, Whole Foods states that one of their primary growth strategies is to continue acquisitions and new site developments. According to the Federal Reserve Board’s September 3rd, 2008 Beige Book, overall commercial real estate activity has weakened in every market except Dallas. However, Whole Foods has 86 leases for stores opening through the fiscal year of 2010. With the development of these new stores and the given economic conditions on the United States, it is unclear if these stores will be of any profit to Whole Foods in the coming years.

Whole Foods Market Incorporated’s primary market is located within the United States. Currently, Whole Foods owns and operates 276 stores in the United States with a fairly even demographic distribution. The exact regional percentages are displayed in figure 1.1. Since Whole Foods is represented in all regional markets across the United States, the data found in the Federal Reserve’s Beige Book for September 2008 is a good indicator of economic conditions the company faces. Although they have a few locations in the United Kingdom and Canada, a significant percentage of the firm’s revenues are generated here in domestic markets.

Industry Analysis
Whole Foods Market (WFMI) pioneered the supermarket concept in natural and organic foods retailing and is by far the world’s #1 natural foods chain. After merging with rival Wild Oats Markets in August of 2007, the company now operates 276 stores in the United States, Canada, and the United Kingdom. Whole Foods Market specializes in natural foods which are free of pesticides, preservatives, sweeteners, and cruelty, but also in organic foods which are defined as having growing methods intended to support and enhance the earth’s natural balance. Whole Foods Market refuses to sell any product containing additives, preservatives, artificial ingredients, hormones, or antibiotics. Two thirds of the company’s sales come from the perishable products it emphasizes. The relatively new sector of natural food stores now accounts for 10% of the supermarket industry. Whole Foods Market recoreded $6.6 billion in revenue in 2007

Increased health-consciousness among consumers has greatly benefitted the industry of natural food stores and this trend will continue. Consumers not only enjoy the benefits of eating healthily, but also find natural food stores attractive and fun to shop at, although significantly more expensive than traditional supermarkets. This trend has made traditional supermarkets reevaluate their business models and has brought about improvements in customer service, product selection, and store design across the entire supermarket industry. Natural and organic foods retailing have been the fastest-growing segment in the United States grocery business. Conventional supermarket chains have experienced shrinking market shares and profits in recent years while Whole Foods Market enjoyed three consecutive years of double-digit growth from 2004 to 2006.
Whole Foods Market has been growing rapidly by building and acquiring new stores. The $565 million purchase of its rival Wild Oats Markets in 2007 gave the company 109 new stores across the United States; some in attractive new regions in the Pacific Northwest and in Florida. In addition, the company is expanding its European operations by acquiring and opening new stores in the UK. These new stores in the UK have lost $18.4 million in the past year. Whole Foods Market had announced plans to open hundreds of stores across Europe. By adding 25-30 new stores a year, the company planned to reach $12 billion in sales by 2010, up from the previous goal set at $10 billion. Whole Foods Market has toned down its aggressive growth strategy during the last 12 months. Recent economic conditions in the United States and abroad will delay expansion plans. The company has announced it will reduce its new store openings by 50% this year.
Historical Performance of Whole Foods Market
Comp Stores Sales Growth
Square Footage ('000 Square Feet)
Square Footage Growth (%)
New Units (Excluding Acquisitions)
End of Year Store Count (Ex. Acq)
New Store Productivity (%)

Whole Foods Market is the market leader which differentiates itself through the innovative and unique quality products it offers. Years of rapid growth and increased competition from large supermarkets such as Wal-Mart, which seek to affordably offer natural and organic foods to the public, have put pressure on Whole Foods Market to meet its financial goals. The company has several competitors. Trader Joe’s has nearly the same amount of stores and differentiates itself with bargain prices and a laid-back attitude. Smaller regional natural foods chains exist across the country. Conventional supermarkets want a portion of the natural and organic foods market and to enjoy the significantly larger profit margins of specialty products. Chain supermarkets are stocking natural and organic items and creating entire departments devoted to these products. Several smaller companies in the industry compete directly with Whole Foods Market by offering value-priced organic and natural products. Others are competing by offering a broader variety of fresh fruits, vegetables, meats, and seafood than Whole Foods Market. Struggling traditional supermarkets have updated their produce departments by boosting fresh, locally-grown produce. Wal-Mart began its entry into this market carrying only organic milk, baby food, juice, produce, and pasta. In order to attract more affluent shoppers, it has doubled the amount of organic products it offers and currently is the #1 seller of organic milk in the United States.
Rising food and gas prices along with the economic slowdown have especially affected the company’s growth this year. Shares have dropped from a 52 week high of $53.65 to $19.82 (9/23/2008) as gross margins narrowed more than expected from rising food cost inflation and increased store promotions. Many consumers have been scared away from the upscale grocer and its competitors in the natural food market industry. The high quality image that has fueled Whole Food Market’s success does not appeal to consumers with diminished purchasing power from inflation and growing unemployment. Inflation-adjusted income dropped 2.6% in June. A survey conducted this year reported that 19% of organic food shoppers are buying less organic and natural products. The idea that “once you buy organic, you don’t go back” has been disproved this year. While some conventional grocery stores are seeing increased demand as consumers choose to eat out less often, the upscale image of Whole Foods Market is not drawing these consumers into its stores. Whole Foods Market has placed “value gurus” in its stores to direct customers to various discounts and savings opportunities in an attempt to tone down its luxurious image.
CEO John Mackey has announced that Whole Foods Market plans to cut all discretionary capital expenditures that aren't related to new stores by 50%, and is also "actively working to drive down the average development cost per square foot" in its stores. Analysts believe that current market conditions will trigger a greater efficiency in the company’s stores. While management is currently cutting back on capital spending, the company is positioning itself to see increasing returns as the economy improves. Investors are evaluating the natural foods industry as a whole and whether it is in jeopardy. Most analysts agree that while Whole Foods Market will continue to see short-term weakness caused by dreary consumer confidence, the long-term industry outlook is healthy. Most still believe the market niche for high-quality natural and organic foods will expand over time.
As the leader of the natural food market industry, Whole Foods Market’s success will depend on its ability to navigate through the economic slowdown without losing its market share. Many consumers are changing their preferences in the short run due to a decrease in disposable income. Whole Foods Market will continue to offer discounts and savings opportunities to keep customers visiting its stores while not harming its image as a high-quality natural food market which differentiate the stores from competitors. The economic slowdown has forced the company to reevaluate its stores and look for inefficiencies that may have been overlooked during the rapid expansion in recent years. Long-term growth appears healthy in the natural food market industry given trends in the past decade but short-term growth will be slow. Analysts predict that EPS will be $0.134 this quarter. EPS estimates for the following three quarters are $0.295, $0.296, and $0.28.
As the leading natural foods store in the United States, Whole Food’s main economic advantage is its size. Already the leader in its category, it became even more of a powerhouse in 2007 when it acquired its biggest rival Wild Oats Markets, Inc. John Mackey, CEO of Whole Foods Market, said of the acquisition, “We expect that over time we will recognize significant synergies through G&A cost reductions, greater purchasing power, increased utilization of our facilities and new team member talent” (Annual Reports). From the acquisition, all 11 operating regions of Whole Foods have gained new stores. In addition, Whole Foods gained entry into a 5 new markets.
Whole Foods sets itself apart from all grocery stores (not just natural foods stores). It offers an upscale shopping experience, a variety of restaurants in each store, environmentally friendly products, and a mission that stays in the forefront of its business practices. Whole Foods itself states, “We believe that much of our success to date is because we remain a uniquely mission-driven company” (Annual Reports). The store also provides a different kind of culture. One customer explained, “Pizza makers flip dough high above their heads. Fish mongers throw fish across the seafood counter, just like at Pike Place.” She also raved about the employees, saying that Whole Foods, “Hires for attitude, trains for skill” (I’m moving in with Whole Foods). In addition, one of the main ways the company differentiates itself it through its high quality produce section. Perishables account for approximately 67% of total retail sales at Whole Foods. If turnover slows down the profit margins will likely decrease as well. The company’s 10-K report states, “We believe it is our strength of execution in perishables that has attracted many of our loyal customers” (Annual Reports).
Another advantage of Whole Foods is that they seem to have been at the right place at the right time. In the last decade, the American populous has become much more aware, and has taken action against, consuming unhealthy food. Whereas a natural foods store may not have been successful fifty years ago, consumer awareness has now allowed for the natural foods niche to grow considerably. Consumers who once shopped at any grocery store are now taking their business to natural, organic grocery stores.
With the present economic conditions, Whole Foods has been facing most of its competition from more mainstream grocery stores such as Wal-Mart. Consumers who once were able to spend their money on organic products are now opting to buy cheaper, non-organic groceries. In order to combat this trend, Whole Foods has begun employing “Value Gurus” in their stores. These Value Gurus help point shoppers to sales and bargain deals. Also, to protect the company’s ideas from competitors, Whole Foods enacts a strict policy of no pictures or videos.
Business Lines
Whole Foods operates in one reportable segment, natural and organic foods supermarkets. Within this segment product categories include produce, seafood, grocery, meat and poultry, bakery, prepared foods and catering, specialty (beer, wine and cheese), Whole Body (nutritional supplements, vitamins, body care and educational products such as books), floral, pet products and household products.
Whole Foods also provides their own private labels that are generally less expensive than other products carried in their stores. These labels include 365 Everyday Value, 365 Organic Everyday Value, and Whole Brands.

Ratio Analysis
To completely understand the return on equity of Whole Foods, we compared it to companies in similar industries as Whole Foods. This is a bit difficult because Whole Foods operates in a niche market. The higher end organic grocery stores have few competitors in the organic market itself, but their biggest competition is the grocery industry as a whole. When contrasting Whole Foods with other grocery stores, the result was a good indication of how Whole Foods’ profit growth, asset utilization, and financial leverage strategies compares to companies selling similar products. We chose five other companies in the grocery industry. The first was Safeway (SWY) a principal food and drug retailer in the United States. Second we chose Publix Super Markets (PUSH) which is located primarily in southern states, but has a similar number of stores. We also chose Weis Markets (WMK) located primarily in Pennsylvania and offers additional services comparable to Whole Foods stores. The Kroger Company (KR) also manufactures their own foods, but they are a bit larger and offer a more comprehensive shopping experience. Finally, we compared Whole Foods to The Great Atlantic & Pacific Tea Company (GAP), which operates 447 grocery stores under many different names. GAP also has a private label that they market and sell in their many stores. It is difficult to compare grocery stores closely because they each operate in their own unique niche. We have chosen a large sampling with stores that have aspects easily comparable to Whole Foods’ business.

Tax Burden Ratio (Net Profit/Pretax Profit)

Tax Burden Ratio
Whole Foods

Whole Foods has maintained a consistent tax burden radio through the past 5 years of about 60%. Excluding outliers, such as Safeway’s tax burden ratio of 123% in 2003 resulting from negative net profit in that year, the industry average has also remained fairly stable maintaining a ratio in the mid-60’s. This means that, on average, the income tax rate in the grocery industry hovers around 40%. For Whole Foods, this rings true. Except for 2005 when their tax rate was 42%, their income tax rate has stayed at 40%. So, while other grocery stores had negative net profit, Whole Foods was always able to keep profits positive. In fact, its general trend has been profit growth. Not surprisingly though, this trend did not continue in 2007 due to recent economic conditions which have caused consumers to shop at other less-expensive grocery stores.

Interest Burden Ratio (Pretax Profit/EBIT)

Interest Burden Ratio
Whole Foods

In order to obtain pre-tax profit from EBIT, interest expense on debt is subtracted from EBIT. Whole Foods has maintained a stable interest burden ratio in the high 90’s – meaning that their interest expense on debt is rather low. Industry averages have remained somewhat consistent, fluctuating around the 80’s. Whole Food’s interest expense hovers around $5.7 million, while other grocery stores interest expense, such as Safeway’s and Kroger’s, stays around $400 million. Four out of the six stores in our industry have interest expense on debt, and of those Whole Foods is the only store with such a low expense – meaning that while they do rely somewhat on debt for leverage, they are not as levered as other companies in their industry and are able to keep more of their EBIT.
Profit Margin (EBIT/Sales)

Profit Margin
Whole Foods

Profit margins have tended to go up since 2003, with three out of the five companies comprising the industry averages having consistent increases of their profit margins in the past five years. But other than that, the overriding industry trend has been to have consistent ratios. There is no year where any ratio has had any significant increase or decrease across companies. Considering the industry we are analyzing – food, a commodity – this really is not that surprising because food is a staple in the economy, and no matter how the economy is doing, people will always need to eat. On the other hand, while profit margins have remained stable, they have also remained low because food is a commodity.
Whole Foods has been able to keep a high profit margin in relation to the industry because they charge a premium on their goods. But, while Whole Foods has kept a relatively stable profit margin in the last five years, in 2007 this ratio went down more than 1% because its sales went up while its EBIT went down. This can be explained by their decision to decrease prices to keep customers during this economic downturn. While this downturn persists, it can be expected that their profit margin will remain lower than in previous years.

Asset Turnover Ratio

Asset Turnover
Whole Foods
Industry Average

The asset turnover ratio is a measurement of a firm’s use of their current assets and their fixed assets. In other words, this is the annual sales generated by each dollar of assets. Although it is very close, Whole Foods sales to assets ratio is consistently lower every year. At its largest gap, Whole Foods is approximately 16% lower than the average in 2007. The reason that the industry may consistently have high asset turnover ratios is due to the fact the grocery industry has relatively low profit margins. It is also noted that Whole foods does not have a steady increase or decrease in their sales to assets ratio. Whole Food’s sales and assets both increase at a steady rate, this most likely means that there are external forces that can explain the fluctuation. Sales can fluctuate according to consumer buying habits and economic conditions. Whole Foods has experienced steady sales growth most likely due to their rapid expansion into new markets over the past five years. Assets have increased corresponding to growth in the number of stores. Analysts can also look at the trend in the Asset turnover ratio to see if the company is becoming more efficient in the use of their assets to generate revenue. From 2003 to 2004 Whole Foods’ reported a leap in their ATO ratio reporting a 29% increase from the previous year. The industry average also took a giant surge in the average ATO reporting a 15% increase, the highest increase of the years shown.
Factors that play into higher in ATO ratios would possibly be fixed asset valuation falling or margins increasing. The key in a grocery industry would be to keep low margins on their products and encourage high turnover in their stores. This is optimal because such a large percentage of their inventory is perishable goods. The difference could also be related to the fact that, on the whole, Whole Foods’ stores are newer than the other grocers. They are also more upscale compared to the competitors. Both of these factors would result in a lower ATO, but it is compensated by higher margins. It is not likely dues to property valuation increase because they only own seven stores, two distribution facilities, and a few pieces of land. The rest of the stores are operated under 5-year leases.

Assets To Equity Ratio

Whole Foods
Industry Average

The Asset to Equity ratio is a measure of the firm’s financial leverage and long-term solvency. This number specifies the amount of debt Whole Foods uses to operate. Whole Foods consistently has a lower Asset-to-equity ratio compared to other firms in the same industry. This means that they do not need or want to borrow as much as other companies in order to operate. Although they have remained below the industry average, the industry’s Asset-to-equity ratio has not increased significantly where Whole Foods has seen a large increase. Since Whole Foods has been growing in size so rapidly, it is likely that they have taken on more debt to finance their advancement in the market. One reason for this could be the fact that in 2007 Whole Foods acquired one of their main competitors, Wild Oats. In order to pay for this transaction, Whole Foods entered into a five-year $700 million loan agreement. Approximately $21.8 million in Wild Oats and $2.7 million in Whole Foods Market convertible debentures, approximately $19.4 million in capital lease obligations and approximately $17 million in borrowings on the Company’s revolving line of credit. Subsequent to the end of fiscal year 2007, the company paid off the Wild Oats convertible debentures and the credit line balance.
It is probably safe for them to increase their ratio and take advantage of the financial leveraging possibilities in the market. An asset to equity ratio of more than 2.0 means that the companies are using more debt than equity to finance their operations. The industry average is considerably higher, close to double of Whole Foods each year. This could mean that many companies are finding it more practical (or necessary) to obtain large amounts of debt to finance the company. Whole Foods may benefit from obtaining more debt because it seems that their competitors are
Return On Assets

Return On Assets
Whole Foods
Industry Average

Return on Assets informs an investor how well earnings were generated from invested capital. Between the years of 2003-2006 Whole Foods remained lower than the industry average for their return on assets. This means that they were not as efficient at using their assets to grow the business and generate sales using their own capital investments. In 2007 they were slightly higher than the industry average, but this was due to a significant decrease in the ROA average of the grocery industry. The ROA of the grocery industry are generally pretty low due to their high volume turnover.
Their ROA trend has seen an increase from 2003. It is better to have a high Return on Assets because when a firm has a higher ROA they are a more attractive security to potential investors. Firms with higher ROA are more attractive because they offer prospects of better returns on the firm’s investments. ROA also gives an indication of the management’s performance and use of assets. The increased ROA from year 2003 to 2007 shows that management has become more efficient in operations.

Compound Leverage Ratio

Compound Leverage Ratio
Whole Foods
Industry Average

The compound leverage ratio indicates the total impact of leverage in the ROE equation by multiplying the interest burden by the leverage. Financial leverage helps to boost ROE but only if ROA is greater than the interest rate on the firm’s debt. By looking at the compound leverage ratio, we can see just how much the leverage has on ROE and ROA. Whole Foods has less debt then the rest of the industry and this could be a factor as to why their compound leverage ratio is lower then the industry average. If they have less debt to invest in, they should have less of a payoff because of that. Despite having lower compound leverage ratios then the industry averages, Whole Foods’ ratio is still rather strong in terms of their own company. Whole Foods’ compound leverage ratio is above 1 in all of the five years, we can assume that they have had a positive contribution of financial leverage to their ROE. That is that the debt that they are taking on has been of benefit to them. This is a positive thing for them because if they have higher compound leverage ratio, they will have a higher return on their equity, given that the tax burden and ROA do not both decrease. Since both their ROA and their tax burden ratio have remained fairly constant, we believe it is a fair assumption to make that their ROE will continue to be relatively constant.

Return on Equity and Debt to Equity

Whole Foods
Industry Average

Debt to Equity
Whole Foods
Industry Average

Return on equity measures the profitability for contributors of equity capital and helps to determine the firm’s growth rate of earnings. Basically, ROE can be computed by dividing the net income by the shareholders equity. Whole Foods has remained relatively constant in these numbers, floating between about 10-14%. The Industry Averages, on the other hand, are not quite as stable and range from 22% all the way to -1%. The ROE can be useful in comparing companies’ profitability to those who do similar business to them. ROE is very important to investors because it shows them exactly how the company is doing in regards to reinvesting and earning on their equity. Obviously, the higher the ROE, the more attractive an investment will be. Whole Foods has been above or within 1% of the industry average three out of five years. Being consistently steady and at or above industry 60% of the time in the past 5 years, the ROE of Whole Foods seems to be a positive benefit. Since Whole Foods was rapidly expanding their number of stores and investing in new markets but has recently in the past 12 months slowed this down, this might explain the increase to the decrease between 2005 and 2007.
Whole Foods has, in 2007, increased their debt to equity ratio from .43 to 1.13. Going back to previous discussions, this could be partly because of the large loan they took on during the acquisition of Wild Oats. Normally with this increased debt to equity ratio, a company might have trouble paying the interest and principal while still seeking more financial funding. However, also as previously mentioned Whole Foods has met the requirements of their loan and seem to be in a solid position to continue to meet these requirements in the future from the assurance provided as they have met them already without any problems. In addition, their debt to equity ratio is still below the industry average, where it had been consistently below all the way back through 2003. So the last increase in debt will most likely have a large effect in their ROA ratios in the 2008 year where they will be able to first compare the cost of their investment to the actual outcome they will experience. Since their ROE decreased, it might be assumed that ROA fell below the interest rate in 2007, as explained in the compound leverage ratio section.
Trend Comparison to Section I
In Section I, many economic advantages of Whole Foods were mentioned. Their biggest economic advantage being that of their size in their industry following with things such as a large portion of sales coming from perishables, the timing of their entrances, the shopping experience, and their environmentally friendly products compared to traditional grocery stores. As mentioned previously, Whole Foods recently acquire Wild Oats which in essence will increase their assets along with many other financially important values. This increase in their assets will carry through and affect ROE, however many of these affects will not be recorded until the 2008 fiscal year. Already though, Whole Foods has been affected by the acquisition in their 2007 financial reports with their sales. The slow growth most likely is due to their fast expansion into multiple new markets and that those markets have not met their potential for Whole Foods. This economic advantage however will definitely be seen through many ratios and values in 2008, if not already in 2007.
Another main point that will be seen in the various ratios and values is the fact that a big portion of their sales comes from perishable goods. Most grocery stores, as it is, have relatively low profit margins and high asset turnover ratios. Since sales fluctuates greatly with states of the economy and consumer buying habits, Whole Foods will be affected by the current economic slowdown and changing consumer spending habits when already its profit margin went down more that 1% because its EBIT decreased. If the slow economy continues, Whole Foods will have to find other advantages or use their advantages of the shopping experience, variety of restaurants in the stores, and environmentally friendly products to help keep their sales up. Other than through sales, these economic advantages might be difficult to see how they will affect Whole Foods’ various ratios. Furthermore, the timing of decisions of Whole Foods in the industry has also been extremely beneficial for them. In the next year, the timing of the acquisition of Wild Oats will be able to be seen through all of their ratios and the effect of the current state of the economy and their size might be a cause of disadvantage instead.

The Capital Asset Pricing Model is defined as:

CAPM = Rf +β[E(RM)- Rf]

All variables in the CAPM equation must be determined in order to compute the dividend growth model. Computing CAPM will give a precise prediction of the relationship observed between the risk of an asset and its expected return. The risk free rate is the first component of CAPM that can be determined. The risk free rate is generally the interest rate that can be earned with a fair amount of certainty. We will use 3.17 based on a 10 year Treasury note rate on November 21, 2008.
Whole Foods’ β is reported at 1.1 according to ThomsonOne Banker. ThomsonOne computes their beta by taking the slope of a line fitted between 156 observations of weekly relative price changes. These observations are equal to the ratio of the weekly percent price change in a particular stock to the weekly percent change of the S&P 500. They use the least squares regression equation to calculate the slope.
The next variable from CAPM that we need is the return on market (Rm). The S&P 500 is known to be the best representation of the U.S. equities market. We can use the average historical market return of the S&P 500 in the CAPM equation. According to ICMA-RC organization, the average S&P 500 is 10.336% over the past 82 years. Once all the variables have been found, CAPM can be computed. Whole Foods CAPM is equal to 11.05 (3.17 + 1.1(10.336-3.17)).

Growth Ratio
Growth = ROE + b

The growth ratio is determined by multiplying return on equity (ROE) by the plowback ratio (b). As we determined earlier, the return on equity for Whole Foods in 2007 fiscal year was 12.53%. In order to determine the plowback ratio, the dividend payout ration has to be computed. The dividend payout ratio is found by dividing dividends per share by earnings per share. In 2007 Whole Foods reported $0.72 dividends per share. They also reported a $1.29 earnings per share. The dividend payout ratio would equal 55.8% ($0.72/$1.29). The plowback ratio (b) is equal to 1 minus the dividend payout ratio. This is sometimes referred to as the earnings retention ratio because it is the fraction of earnings that are reinvested in the firm. The plowback ratio for Whole Foods is (1- .558)or .442. Now all the components to calculate the dividend growth have been identified. Whole Foods sustainable growth rate would be 5.538% (12.53% x .38).
To compare this rate, we can calculate the over all growth of the company by computing growing in sales over the period. We found Whole Foods rate to be exceedingly high. Their sales growth rate numbers are very high for this period because they were undergoing a period of rapid expansion. We found this rate to be unrealistically high because these rates will not remain this high for much longer.

Sales Growth

We also found the earnings per share growth rate to be a little better estimation of growth. Whole Foods EPS growth rate over the period is 9.22%. We also feel that this number is also a bit high and they may have peaked so it is not a good growth number to use for future estimates. Whole Foods’ has 5 years of historical quarterly summaries available on their website. Reference the estimated growth rate for fiscal year ending 2008. They, as a firm, estimate a lower growth rate of 5%. We will use this growth rate to calculate the dividend discount model.
Dividend Discount Model Approach
One approach to valuing the stock of a company is the dividend discount approach, which in essence values a firm based on discounting future dividends. Evaluating Whole Foods price under the dividend discount approach, the following information and numbers used for calculations have been gained through the relevant information from the Thomson Financial Full Company Report and also through our previous calculations of Whole Foods’ ROE and their sales information. There were many factors that were looked at to decide what DDM model to use. Given their high payout ratio, dividends, and beta, we believe Whole Foods to be a cyclical consumer goods company. Since it is a cyclical company, it will have variations in its growth and payout ratios depending on what part of the life cycle it is. Given these facts, we used the DDM, three-stage growth model to present value our firm for a time period of ten years.
As shown below, with an EPS growth rate starting at the current initial five year average, 9.2%, they will continue to grow at that rate for an additional two years before declining to a slower rate, before eventually coming down to a steady rate of 3.0%. Whole Foods has had a very high payout ratio over the last few years. Reaching all the way up to 64% two years ago, we estimated that it would start out around 60%. We believe that they will continue their high payout ratio since it is historically what they have been doing despite the amount of earnings. With increased earnings however, we believe that they will continue to have higher payout ratios at 60% then eventually decrease to a steady 40% for at least the time being after that. We decided these shifting rates in the growth and payout and you can see the breakdown the spreadsheet graph that is displayed below. In order to get $14.69, we assumed the varied growth and payout ratios and we were then able to determine forecasted EPS. The forecasted EPS was used with the Payout Ratio in order to forecast the dividends. We then found the terminal value, totaled the dividends, and then present valued them to get what we believe the price of Whole Foods to be worth at this time ($14.69).


There are many of the factors that could have large impacts on the estimated value of the stock. One component, for example, is the capitalization rate. If we were to change the capitalization rate, it would have a large impact on the value because we are using the capitalization rate in the present value formula and when computing the terminal value. There were many options we could have chosen for Whole Foods’ beta. We chose the one we felt best in comparison to them all. Had we chosen a different beta- one that was a tenth or even two-tenths bigger or smaller- it would have changed the capitalization rate by that much. In turn, it would have impacted the value of the stock by that much more and then some. Our value using this model is based on our best estimates and assumptions of how Whole Foods has already performed and how they will perform in the future.
Looking at historical prices of Whole Foods, it had at one point been trading over $40/share at in the past year. It has been trading between $8 and $10 in the past couple weeks. Comparing the value we found using the three-stage growth model, we can conclude using this model that Whole Foods is currently being undervalued. Although the three-stage model is a fair estimate of valuing Whole Foods’ stock, we will re-value it using various other approaches in order for us to choose the best estimate of what the actual intrinsic value of Whole Foods is.
P/E Ratio Estimation Technique Analysis
In order to obtain comparable averages, we used tools in Thomson ONE Banker and compiled a list of 17 comparable companies in the grocery industry. The values we included to compares companies included: Sales, PE Ratio, LTG, Div POR, Beta, PEG Ratio, and EPS. Initially 157 companies made up the list; however, many were quickly eliminated due to lack of information and/or extreme values preventing us from arriving at true values of the averages of the industry. Below are the companies that we compared to Whole Foods in order to represent the industry as a whole. This information was used to compare five different methods of finding our company’s intrinsic value.

The first method used is based on a calculation of the average P/E ratio of the industry by the EPS of Whole Foods. The average P/E ratio was found to be 22.02 and the EPS of Whole Foods was $1.29.
Given these values and calculation the intrinsic value would be $28.41.
The second method used was derived from a calculation of the average PEG of the industry multiplied by the long-term growth of Whole Foods multiplied by the EPS of Whole Foods. The PEG value is found by taking the price per earnings of a company over its growth. Excluding Colruyt, which is an outlier with a PEG of 14.39, the average PEG of the industry was calculated at 1.70. The estimated long-term growth of Whole Foods is 5.00, and, as mentioned previously, the EPS of Whole Foods is $1.29.
Using this method, the intrinsic value of Whole Food’s stock price is calculated to be $10.97.
Method three involved visiting the website in order to find the coefficient values of the growth, POR, and beta averages of the S&P500. These values are then applied to the regression calculation. The following calculation was provided by the website:
PE= 2.74 +142.63g +5.67Payout +.55Beta

Exp. PE

Given the PE ratio above, the growth (5.00), POR (70.34), and beta value (1.1) were used to calculate an estimate PE of 13.87. The estimated PE was then multiplied by the EPS of 1.29 to arrive at an intrinsic value of $17.89.
The fourth method is very similar to the third method, except that this method is done at the industry level. Essentially, this method is a function of the industry growth, beta, and payout ratio values. A regression analysis was run on the industry data collected to find the coefficients of the industry. The coefficients that resulted were 13.40 for the intercept, .667 for the growth, 1.09 for the beta and -.068 for the dividend payout ratio. The equation follows:
PE= 13.40 +.667g +-.068Payout +1.09Beta

With this P/E value, the estimation was found by multiplying it by the EPS of Whole Foods to arrive at an intrinsic value of $16.96.
The fifth method that we used to calculate the intrinsic value of Whole Foods involved multiplying the expected PE of Whole Foods (11.4) by its EPS (1.29). In order to calculate the expected PE, we first had to find the average WFMI vs. S&P of years 2003-2007 and than multiply that number by today’s value of the S&P 500 (17.54). This yielded an intrinsic value of 14.72. The Excel table is shown below.


S&P 500

P/E Yr End

WFMI vs. S&P





Exp P/E

Exp Price

PVGO/Market to Book Ratios
The present value of growth opportunities (PVGO) is net present value of these investment opportunities. In other words, it is the sum of the value of the assets already in place in addition the future investments that the firm will make. Also, tax shields provided by the deductibility of interest and the benefits of other investment tax credits are calculated separately. PVGO analysis is often used for highly leveraged transactions like a leverage buy-out. The price is computed by finding the no-growth value of each share and adding it to the PVGO. The intrinsic value that we computed that best represented the value of Whole Foods was $10.97 per share. This estimate of intrinsic value was computed using method 2 of price/earning analysis. Based on our P/E calculations, we have decided to value Whole Foods at $10.97 – which we determined by using our second P/E method. This value is most closely related to the actual value today of $10.19, and we believe that it is a good indicator of Whole Food’s intrinsic value. The PEG of the grocery industry, which we found using by averaging PEG rates of comparable grocery companies, was calculated to be 1.70. While the historical growth rate of Whole Foods has been very high at around 13%, Whole Foods will not be able to maintain such a high rate, and so we have decreased that value to 5% in order to more mimic the industry rate. Therefore, we believe that using a P/E calculation that takes into account the industry growth rate while also considering Whole Food’s ability to grow after this economic downturn is a viable option
In 2007 Whole Foods reported a earning per share of $1.29 and a required rate of return of 11.05%. Rearranging the formula for price = no-growth value per share + PVGO, we can assume that price – no-growth value per share = PVGO. Subtracting the no growth value per share from the assumed forecasted price of the firm, we arrive at a PVGO of 3.61 (10.97 – 11.67= -.70, where 11.67 equals the earnings divided by capitalization rate or 1.29/.1105). Since Whole Foods has a negative present value growth rate, it is likely that people will not want to invest because of the lack of growth potential that they see. While Whole Foods’ has an ROE that is a big higher than k, which generally means that they are subject to positive growth in the future, but these calculations of the PVGO, we have come to a contradict this theory.
Whole Foods’ current Market-to-Book ratio is .77. The market to book ratio shows how aggressively the market values the firm. The market to book ratio compares the companies’ value in stock price and the net asset value according to the companies’ book value. It can be computed as market price per share divided by book value per share. When comparing Whole Foods’ with some of its competitors- Kroger with 3.21, Safeway with 1.47, Weis Markets with 1.21, and Wal-mart with 2.95- one can see that they are not valued nearly as high as their competitors. This could be an indication and further support that Whole Foods’ is being undervalued.

Over/Under Valuation
Based on our calculations of the DDM and P/E estimation techniques, it is highly plausible that Whole Foods’ stock is undervalued in the market today. With the economy as it is, this does not come as a surprise as the stock market as a whole has been going down drastically in the past year. Investors, in a sort of panic, have been selling of their stock and going into treasury bills in order to “secure” their investments, causing the market as a whole to plummet. Granted, the market was inflated and needed an adjustment, but as of now the market is still at a lower point than what it should be. In due time, it will turn around and correct itself causing Whole Food’s stock value to rise to a more accurate level. If Whole Foods can make it out of this recession (which we think it will), there is a high probability that they will turn from being a growth stock to becoming a value stock. Over the years the company has invested heavily in growth, and now, especially with that economy as it is, they are looking to lessen the pace. Although long-term growth appears healthy in the natural food market industry, short-term growth will be more sluggish. As the leader of the natural food market industry, Whole Foods’ success will depend on its ability to navigate through the economic downturn without losing its market share. If Whole Foods continues to offer discounts and savings opportunities to keep customers visiting its stores, they will be able to keep enough customers to profit in the coming years. In a way, this slowdown is beneficial because it has forced the company to reevaluate its stores and look for inefficiencies that may have been overlooked during the rapid expansion in recent years.
If the intrinsic value of Whole Foods’ is $10.97 and it is currently trading at $10.19 the minimal rate of return would be .07% [(10.97-10.19)/10.19)]. We think it is possible that the stock price will match the intrinsic value soon and probably even beyond the intrinsic value. It is also likely, depending on the conditions, it will lose some of its current value. Because of the uncertainty surrounding it, we think it has the potential to fluctuate throughout the next year.
For the risk adverse investor, it is probably in their best interest not to invest in this stock at this time. Although it is undervalued, there is still a significant possibility that it stays at the current level until economic conditions improve. For investors interested in a value stock, it may be more attractive. Due to the very low Market-to-Book ratio of .77, a value investor would feel that the market has over looked them. Unlike the rest of the market, the value investor feels that the rest of the market has over reacted to bad news and that is a primary reason for the stock to be undervalued. Due to recent economic and market activity, general confidence in high-end companies, like Whole Foods, is probably very low right now. This may be a reason they are undervalued and therefore an attractive investment for someone looking to hold on to an underrated stock.
Overall, though, we recommend it as a hold over the next year. Compared to recent years, Whole Foods stock is misrepresented at this time. It has suffered in the past year because of external forces, such as the economy, but this is not representative of the true growth potential. The eventual value that an investor may realize if they held onto this stock for an extended period of time would probably be much higher. It cannot be said with much certainty whether or not these gains would be realized within the next year.