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02-Dec-09
Closing the WFMI Short Position
Although most of my short sales in weekly newsletter EPIC Insights are based on technical analysis, I will also use fundamental factors to influence my decisions, as when I opted to short Whole Foods Market (WFMI).
A purveyor of high-end groceries, WFMI appeared to be a company that would be hurt by an uneven economic recovery as consumers decided that frugality trumps luxury. In the November 1 newsletter, I detailed my argument that the price of the stock was overly optimistic about how the company would perform in the future. Then trading at a P/E of 36 and having rallied 239% on a year-to-date basis, WFMI was priced for perfection. After I took my short position, better than expected earnings failed to offset a weak outlook and the stock price tumbled. By being properly positioned, we have enjoyed a 20% gain that was against the broad market trend.
Having accounted for those gains, we now must predict whether more upside potential exists. Although I still find the shares expensive, they are not as grossly overvalued as when we made our initial trade. With a forward P/E of 23, WFMI now trades in line with historical valuation. Also, as the shares have declined, the excess return versus its peer group has begun to vanish.
From a technical point of view, the shares are still in a strong downtrend (red line), but are approaching significant support at $25. As with GS, those who are aggressive may wish to hold this position and see if support fails, but I will not. I still believe that the economic recovery will be weak and uneven, which should keep pressure on WFMI's business. However, we shorted the shares when they were overvalued and they no longer are so. Believing that the underlying trend of the market is higher and knowing that excess liquidity could quickly eliminate our gains, I will head to the sidelines and await better opportunities in the future. I recommended closing the short position in WFMI as this week's technical trade.
Tagged Stocks: WFMI
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