Whole Foods: Overreaction Equals Opportunity

 | Feb 13, 2014 | 3:30 PM EST  | Comments
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For nearly 20 years, I made a living in the foreign-exchange market, and in that time I found certain trade signals that, while not perfect, were generally pretty reliable.

When I say that to people who trade in their own accounts, their ears perk up. They believe that I am about to tell them about some magical technical signal, some incredibly complex pattern that they don't know, and that they will suddenly understand why Wall Street traders make money and they don't. They are always disappointed.

Most successful trades are based not on some intricate mathematical formula but on simple common sense. There is little that one can count on in the incredibly volatile and liquid world of foreign exchange, but one thing is for sure: Traders will overreact to news, good or bad. If you think about it, it is only natural. When news comes out, fear of being left out of the subsequent move is the dominant emotion, and the fact that you are paid to trade adds to that feeling that you should do something. The herd mentality that occurs in currency markets also frequently happens with stocks.

Yesterday's release of first-quarter earnings by Whole Foods Market (WFM) produced just such an overreaction. Sure, the company missed on the bottom line, with earnings per share of $0.42, compared with consensus estimates of $0.44. Probably more worryingly, the company cut its forecast for this year for a second time. The news was bad, but was it bad enough to warrant a roughly 10% decline? Probably not.

 

WFM, 52 Weeks
VectorVest

 

Whole Foods is suffering because the market spent the second half of last year overreacting to good news. Analysts and investors alike scrambled to keep up with the company's exponential growth. By the fourth quarter of 2013, they had succeeded, and expectations became so inflated that a beat became almost impossible. When the company missed, they were punished.

Let's not forget that Whole Foods is still growing, albeit at a slightly slower pace than most expected, and to some extent it is doing so in markets that many would not consider its natural environment. Whole Foods is based in Austin, Texas, and much of its growth has been here in the South. I live in North Carolina and had a tendency to view Whole Foods as something like a Tesla or naked yoga -- fine for those big-city and West Coast folk but not really for the rest of us. There is now a Whole Foods Market in my town, however, and it stays busy, even now that the honeymoon period is over.

Of course, the plural of anecdote is not data, so that observation has limited implications, but I do believe that if Whole Foods can succeed here, it can continue to grow. If you accept that basic assumption then this selloff looks like an overreaction, then this is an opportunity.

My hesitation is that there are probably still some nervous, losing longs to be forced out, and there may be more "follow the herd" selling over the next few days. To counter this, averaging in over a week or so may well be the best strategy. But I am convinced that over time it will become evident that just as last year's move up was overdone, this big drop is nothing more than an overreaction to a much-needed dose of reality.

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