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Why Wesfarmers Ltd shares are a better bet than Woolworths Limited

Investors considering the returns from an investment should always consider both the dividend component and also the capital appreciation (or depreciation) component too.

In recent times this has been particularly relevant for income-seeking investors as some have focussed too heavily on the dividend yield of a stock while discounting the importance of possible capital losses.

The total return a shareholder received from an investment is captured in the Total Shareholder Return (TSR) metric which is widely available for listed stocks.

Looking back over the periods of 1, 3, 5 and 10 years, here are the average annual TSR figures for both Wesfarmers and Woolworths:

  • Wesfarmers: -0.6%, 6%, 10.7%, 7.9%
  • Woolworths: -22.2%, -9.7%, 0.2%, 5.6%

(Source: Commsec)

As readers can see, over each of the above time frames, Woolworths has underperformed Wesfarmers in TSR.

Assuming that in the longer term, share price performance follows underlying business performance then it should be reasonable to assume that whilst short term share price underperformance can sometimes lead to mispricing, underperformance over longer time periods can be indicative of a lower quality business.

Indeed, over the past few years, investors have observed an improving performance within the Coles supermarket business (owned by Wesfarmers) and a declining business performance within Woolworths’ supermarket operations.

More recently, investors have observed the disastrous foray by Woolworths into the home improvement market which is dominated by the Wesfarmers owned Bunnings business.

The better bet

Past performance of these two blue chip companies would suggest that Wesfarmers is the higher quality business.

There are other reasons to see the stock as a better bet too…

Firstly, Wesfarmers owns significant coal assets which are currently experiencing bottom of the cycle conditions. The future should be brighter than the present for this division.

Secondly, Wesfarmers has a growth strategy which involves expanding Bunnings into the UK – albeit with associated risks. The growth options available to Woolworths are far less clear or compelling.

Thirdly, based on data supplied by Commsec, the forecast price-to-earnings multiple of Wesfarmers and Woolworths in financial year 2017 is 17.8x and 16.6x respectively. This is hardly a significant discount (or premium) considering the divergent track records of these two companies.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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