Play the sell-off with Whole Foods
You can use the market's weakness to look at stocks that are doing well but have simply become too expensive.
How do you use a sell-off? I've got a ton of methodologies.
You can go back to stocks of companies that have done well and got hammered anyway. You can decide to start picking at stocks you have been waiting for to come down, the preferred way of Action Alerts PLUS. But the one I want to focus on this morning is to look at stocks of companies that are doing terrifically but that simply got too expensive.
Consider the case of Whole Foods (WFM). Here's a company that reported 8.3% comparable sales numbers, one of the highest of all the companies I follow. It has a huge growth path as it only has 342 stores with the ability to have as many as 1,000 before it starts cannibalizing itself. It remains a revered institution with a good housekeeping seal of approval aspect that amazes while at the same time it has been able to close the price gap between "regular" supermarkets and itself to the lowest level since it came public.
Best of all, it is spewing cash and has the least-stretched balance sheet in the business, one that allowed the board to raise its dividend to 20 cents from 14 cents and to continue to buy back shares.
There's only one problem: it sells at 31 times earnings. In this environment, where people are selling anything that's not nailed down -- where Whole Foods represents a huge capital gain and therefore a giant tax hit next year if nothing is done about the fiscal cliff -- Whole Foods becomes Public Enemy No. 1 for the taxable investor. There's just too much gain NOT to take.
So what do you do? You figure out, OK, where would Whole Foods be a gift? At what price would a 15% grower that can grow for years and years be regarded as cheap? What would you pay for the roughly $3.00 that the company can earn next calendar year?
To me, an ideal price might be 25 times earnings. You are not going to get a quality company like this on the cheap -- not one with this reputation, this management and this balance sheet.
I think anything more than 25 times earnings, or $75 a share, you take a pass. Remember, this is how you use a sale, not how you let it use you. Plus, when it gets to $75, I wouldn't even put on a full position. Much better to buy half and then wait, say, until it sells at 22 times earnings to buy more, and then 20 times earnings to buy the rest.
Sure, if the growth rate suddenly slows, you are going to lose a lot of money. But you will be buying it at a cheap rate historically and that's the correct prism for higher-growth investing.
You can do this exercise with a whole bunch of companies. I am only picking on Whole Foods because the quarter was everything you could ever want out of a company except for one that is so expensive that nothing could ever be enough.
Jim Cramer is a co-founder of TheStreet and contributes daily market commentary to the financial news network's sites. Follow his trades for Action Alerts PLUS, which Cramer co-manages as a charitable trust and has no positions in stocks mentioned.
More from TheStreet.com
I hear all these people crying about the fiscal cliff.Do I have to tell everybody what is
going to happen?The Pres and the congress is going to reach a compromise that
nobody really likes.It will happen about Dec.18th.Congress is not going to miss their
Christmas vacation.They will extend a few tax breaks and pat themselves on the back
we can all sleep for now.Just laugh when somebody says "THE SKY IS FALLING".
I've done well using the 7 times earnings guideline (among others).
What most politicians can't figure out is that a whole lot of the upper 5% are a) losing or making very little money on investments b) building the nest egg in deferred accounts or c) refusing to invest new monies into businesses or stocks.
If we had a 90% tax rate on earnings over $1 million would it eliminate the deficit?
I don't think so. Anyone have the numbers?
I don't believe we can tax our way out of this hole. By the way, isn't Obama a member of the 1%?
This is the gift horse buying opportunity.I`m buying big time.In a few weeks the Dow will
be up to all time highs and you`ll be kicking yourself for not buying now.Get over the
election, it`s time to BUY!
Cramer you should never never pay more than 7 times earnings for a company stock
at least back in the normal days when people did not lose everything they had in the market that is what they told people.
25 times earnings is more than 3 times what you should pay for a stock.
The stock market is totally in a bubble folks
Copyright © 2014 Microsoft. All rights reserved.
Stocks are facing some serious resistance as the bears tear into the market's respite.
VIDEO ON MSN MONEY
Contributors include professional investors and journalists affiliated with MSN Money.
Follow us on Twitter @topstocksmsn.