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Woolworths’ shares reach new high

Supermarket giant and retailer Woolworths (ASX: WOW) reached an all-time high share price last week of $36.84 before closing the week just off the high at $36.40. With the stock up over 25% in six months and certain metrics starting to look a bit stretched, investors need to be asking how much further Woolies share price can run.

Underlying growth in the first half was solid with net profit after tax increasing 5.5% and management issuing guidance to expect the full financial year (FY) to show growth in the range of 3% to 6%. This level of growth is reasonable for a business with the size and market share of Woolworths.

However the run up in the share price does place the company at an estimated price-to-earnings (P/E) ratio for FY2013 of about 19. While the quality and defensive nature of Woolworths does deserve a premium to the market multiple, this would appear to be a very full price to pay for this company. What’s more, with a consensus forecast dividend of $1.33 per share, Woolies is yielding just 3.65%.

So buying Woolies today will earn you less from dividends than you would get from a high-interest bank deposit and you run the risk of overpaying, which will affect your ability to earn a decent return from the investment.

Other options

Purchasing rival Coles, Target and Kmart owner Wesfarmers (ASX: WES) means investing in a company exposed to much more than just the retail sector. So it is not a perfect comparison but does still make an interesting study. On consensus forecasts, Wesfarmers is at a P/E of over 21 times and the stock is yielding 4.5%. A higher multiple than Woollies is arguable justified given Wesfarmers’ potential to continue to improve returns from efficiency gains at Coles. However its exposure to Coal production has probably more downside risk than upside potential so it is a difficult call.

Metcash (ASX: MTS) is the third largest player in the domestic supermarket space, owning the IGA banner brand. Metcash is forecast to pay 27 cents in dividends in the next 12 months, giving it a healthy 6.6% yield. With a forecast lower earnings  growth outlook, the company is trading on a much lower P/E of 12.8 times.

Foolish takeaway

Many studies have shown the important contribution dividends make to overall investment returns. If you invest in stocks with low dividend yields you are effectively requiring the company to provide higher earnings growth to compensate. Woolies doesn’t look to have either high growth or high yield in its favour at current prices.

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More reading

The Motley Fool’s purpose is to help the world invest, better.  Click here now  for your free subscription to Take Stock, The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead.  This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson. Motley Fool contributor Tim McArthur does not own shares in any of the companies mentioned in this article.

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