Tim Bovee, Private Trader: WFM: Bearish on the Foodie Heaven

Update 9/16/2014: WFM moved back within its 20-day price channel, thereby failing to confirm the bull signal. I'm still placing it on the Watchlist to keep track of developments the rest of the week.

Whole Foods Market Inc. (WFM) makes its living in the most mundane of ways: Selling the sort of food that Grandma used to cook, back in the golden days before industrial farming and pink slime. It is a company known for quality products, customer loyalty, a knowledgeable staff of foodies and innovative management, yet it has been on the decline for nearly a year, and a bear signal on Monday suggests that more downside lies ahead.

The Chart

WFM's rise from $3.52 beginning in November 2008 reached a peak of $65.59 on Oct. 28, 2013 and reversed to the downside, ending an astounding bull run that that multiplied the price more than 18 times.

Using Elliott wave analysis, I've labeled that peak as the end of wave 5 {+3}, the final wave in a rise that began more than 20 years ago. In truth, it's impossible with Elliott to say whether that peak is a 5th wave or a 3rd, or even a 1st. I chose to label it a 5th wave because of its length relative to the massive decline from December 2005 to November 2008 that cut the stock to less than a 10th of its former value.

Click on chart to enlarge.

WFM 20 years monthly bars (left), 1 year daily bars (right)

I can say with a degree of certainty that the present decline will be significant, and the fall in May past previous resistance suggests that the decline is real rather than being a head fake. I've marked that resistance point, the end of wave 4 {+2}, with a red arrow on the left-hand chart.

The decline since October 2013 has been punctuated by two large downward gaps, both associated with earnings announcements.

The magnitudes of the waves within the decline from last October are fairly undifferentiated. My count, which puts the end of wave 3 as occurring on July 17, is reasonable, but scarcely definitive. There are other ways of counting.

The one certainty is that WFM reversed upward from the July 17 low in a counter-trend correction. The present bear signal could be a resumption of the main trend downward, or it cold be a fluctuation within an ongoing correction.

Only a break below the $36.09 low set last July can decide the case, and that level is 4% below today's opening price. Waiting for a break below that level would provide more certainty, but at the cost of lost opportunity -- the usual trade-off.

Odds and Yields

WFM has completed four bear signals since the Oct. 28, 2013 peak. Three were successful, on average yielding 89.4% over 41 days. The one unsuccessful trade lost 0.1% over 40 days -- essentially neither a loss nor a gain.

The resulting 8.3% win/lose spread is quite impressive.

The Company

Whole Foods Market, headquartered in Austin, Texas, operates 362 stores in North America and the United Kingdom with a wide selection of organic and natural foods. The Whole Foods near my home is a playground for foodies, both those shopping to cook at home and those wanting a great lunch on the premises. In the window is a large poster in favor of labeling genetically-modified foods, a local issue in this fall's general election.

I added the company to my list of innovators because of their reputation for hiring food enthusiasts as employees and then treating them extremely well. It is a company with a great story and a long-term vision, both articulated by founder and CEO John MacKey in his 2012 book Conscious Capitalism.

So considering a bear position on Whole Foods seems, intuitively, to be contrarian, an affront to a wonderful ideal.

Certainly, it is no affront to the analysts who mold investor opinion. Collectively, they give Whole Foods' prospects a 25% negative enthusiasm rating.

The company reports return on equity of 15% -- high but not awesome -- but with very low debt amounting to just 2% of equity, which certainly adds a degree of awesomeness to the returns.

Earnings have been on a uptrend for at least the past three years, although they stumbled a bit with two consecutive quarters of negative earnings surprises in the first half o f the current year. The "surprise" quarters were, of course, quite profitable, and indeed they equalled or exceeded earnings in all but three of the prior year's quarters.

The earnings yield is 3.91%, and the quarterly dividend yields 1.22% annualized at today's prices.

Projected growth and the dividend suggest a "fair" price of $23.29 per share, meaning that WFM is overpriced by 68%. I've marked the fair price level on the left-hand chart in purple.

The stock is selling for 26 times earnings but at near parity with sales. It takes 99 cents in shares to control a dollar in sales.

Institutions own 77% of shares.

Whole Foods Market next publishes earnings on Nov. 4. The stock goes ex-dividend on Sept. 24 for a quarterly payout of 12 cents per share.

Liquidity and Volatility

WFM on averages trades 4.2 million shares a day and controls a wide selection of option strike prices spaced a dollar apart, with open interesting running to four figures.

The front-month at-the-money bid/ask spread on puts is 7.4%, compared to 0.9% for the most traded symbol on the U.S. markets, the exchange-traded fund SPY.

Implied volatility stands at 25%, compared to 13% for the S&P 500 index and has been falling since its July 30 peak of 48%. WFM's volatility stands at the 23rd percentile of its one-year range, implying that the most successful trades will be structured as long options spreads, bought with a debit and expiring in an out month.

Options are pricing in confidence that 68.2% of trades will fall between $35.40 and $40.96 over the next month, for a potential gain or loss of 7.3%, and between $36.84 and $39.52 over the next week. I've marked the month range on the right-hand chart in blue.

Contracts in today's trading are skewed calls, which are running 48% above their five-day average price. Calls are running 33% below average.

Decision for My Account

The WFM chart is conditionally bearish, and will become more so once the price breaks below resistance. The financials are quite bullish, although that's something that would be a greater concern for a longer-term position.

The liquidity is high, allowing me to construct a leveraged and hedged position, which makes the trade quite a bit more attractive.

I intend to open a bear position in WFM today if downside momentum continues into the half hour before the closing bell. If momemtum falters, I'll add WFM to my Watchlist.

-- Tim Bovee, Portland, Oregon, Sept. 16, 2014

References

My shorter-term trading rules can be read here. My longer-term trading rules can be read here. And the classic Turtle Trading rules on which my rules are based can be read here.

From time to time I use the number 68.2% in using applied volatility to calculate the expected trading range. This comes from statistics and refers to the one standard deviation boundaries, which are expected to contain 68.2% of whatever is being studied. Putting it another way, given an item (a trade or whatever), there is a 68.2% chance that it will appear within those boundaries.

Elliott wave analysis tracks patterns in price movements. The principal practitioner of Elliott wave analysis is Robert Prechter at Elliott Wave International. His book, Elliott Wave Principle, is a must-read for people interested in this form of analysis, as is his most recent publication, Visual Guide to Elliott Wave Trading.

Several web sites summarize Elliott wave theory, among them, Investopedia, StockCharts and Wikipedia.

See my post "Chart Analysis: Nomenclature" for an explanation of my method for labeling waves on the chart.

By preference I place my shorter-term trades in the last half hour before the closing bell in New York. See my essay "When is the best time to trade" for a discussion of the practice.

Disclaimer

Tim Bovee, Private Trader tracks the analysis and trades of a private trader for his own accounts. Nothing in this blog constitutes a recommendation to buy or sell stocks, options or any other financial instrument. The only purpose of this blog is to provide education and entertainment.

No trader is ever 100 percent successful in his or her trades. Trading in the stock and option markets is risky and uncertain. Each trader must make trading decisions for his or her own account, and take responsibility for the consequences.