Woolworths Limited or Wesfarmers Ltd: Should you buy?

Which of the two offer better value?

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Australia’s supermarket duopoly have seriously underperformed the S&P/ASX 200 (INDEXASX:XJO) index over the past year. The index has returned 14.4% while Woolworths Limited (ASX: WOW) and Wesfarmers Ltd (ASX: WES) have returned 10.66% and 6.59% respectively. While the past performance is interesting, it’s the future profit-making potential that really counts. So how do these two wide-moat businesses stack up on current valuations?

Adjusted for the timing of Easter, Woolworths grew sales nearly 6% for the third quarter of 2014 and is implementing its strategic plan to build new growth businesses. This is demonstrated by its move into the Home Improvement market. Woolies now has 45 Masters stores open to directly compete with the Wesfarmers owned Bunnings Warehouse stores. It also posted more than $1 billion of online sales in the last financial year and this is a strong growth area, with click and collect sales more than doubling compared to the prior quarter.

This all sounds promising but trading on over 18 times forecast earnings, Woolworths looks on the expensive side, as it is unlikely to ever shoot the lights out in terms of earnings growth. The fully franked 3.8% yield is one of the most reliable going though, and Woolworths looks a hold for now.

Wesfarmers is trading on over 19 times projected earnings with a fully franked yield of 4.5%. As a conglomerate style business it has diverse ownership interests including Coles, Bunnings, Kmart, and investments in the coal mining industry. It has also recently completed the sale of its insurance underwriting operations to Insurance Australia Group Limited (ASX: IAG). With plenty of cash available after the $1.85 billion insurance business sale, Wesfarmers’ management is on record as saying it is looking to secure growth opportunities through entrepreneurial initiative.

With Woolworths growing net profit for the most recent half year at 14.5% versus the 11.2% achieved by Wesfarmers, it would appear Woolworths offers the better value. The weak prices and indifferent outlook for metallurgical coal could also prove a thorn in Wesfarmers’ side for the years ahead. Both represent solid investments over long-term horizons, but if you’re looking for potentially stronger growth there’s one company with record profits and a fast growing, fully franked dividend…

Motley Fool contributor Tom Richardson has no financial interest in any company mentioned. You can find him on Twitter @tommyr345

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