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Woolworths Limited vs. Wesfarmers Ltd: Which is the better buy?

Over the past 12 months the S&P/ASX 200 (Index: ^AXJO) (ASX: XJO) has lost close to 10%.

In comparison, the share price of Woolworths Limited (ASX: WOW) has slumped 23%, while shares in Wesfarmers Ltd (ASX: WES) have managed to limit their losses to less than 2%.

A tale of two different stories

You will often here fund managers talk about “liking the story” of a company. When it comes to Woolworths and Wesfarmers, two of Australia’s largest retailers, their “stories” appear starkly different.

Investors have fallen out of love with Woolworths. The resurgence of Coles (owned by Wesfarmers) and the resultant tightening of margins, declining growth rates and significant losses suffered from the foray into the Home Improvement segment have been too hard for many shareholders to stand.

Although investors have tempered their expectations on Wesfarmers given the effect of the coal price slump on Wesfarmers’ significant coal division, investors have remained enamoured with the overall Wesfarmers’ story. Apparent top-of-the-cycle asset sales along with the recent announcement that it will export the successful Bunnings brand to the UK have been well received by the market.

Don’t forget about price

While Wesfarmers’ “story” might be more attractive, investors shouldn’t forget to consider the price they are paying for both of these “stories”.

Indeed, it’s worth noting that the share price of deeply out-of-favour wholesale supplier Metcash Limited (ASX: MTS) is 25% higher in the past year after losing over 50% the year before.

What’s changed for Metcash you may ask…arguably the primary difference has simply been investor sentiment.

With Woolworths’ share price still near decade low levels, but earnings expectations having also been trimmed, the forward price-to-earnings (PE) multiple is around 16 times.

In comparison, Wesfarmers’ forward PE multiple is closer to 18.5 times.

If Woolworths’ problems turn out to be temporary and fixable then this peer discount may be unwarranted. Then again, perhaps Wesfarmers is deserving of a premium thanks to its more attractive “story”.

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Motley Fool contributor Tim McArthur has no position in any stocks mentioned. 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.