Wesfarmers Ltd (ASX: WES) shares have been one of the better performers over the past year, rising by 54%. That compares to a rise of 11.7% for the S&P/ASX 200 Index (ASX: XJO).
After such a strong increase, some investors may wonder whether now is a good time to invest in this retail conglomerate, which owns Bunnings, Kmart, Officeworks, Priceline and plenty more.
It's rare for an ASX blue-chip share as large as Wesfarmers to increase its share price as much as it has in just one year.
But there are plenty of positives going in its favour.
Positives about Wesfarmers shares
I think Bunnings, Kmart and Officeworks are great businesses.
In fact, Bunnings and Kmart are category leaders, in my opinion. Their size gives them scale benefits and enables them to provide cheaper products, which is particularly appealing to customers with tight household budgets.
Bunnings and Kmart are the two biggest profit generators for Wesfarmers, and those divisions continue to perform.
I believe that these two brands can continue to capture more market share, add stores to their national networks and grow profit even further.
In the FY24 half-year results, Bunnings saw a return on capital (ROC) of 65.8%, and Kmart made an ROC of 58.8%. This shows the strong returns that money invested in those businesses can make.
In addition, I am impressed by Wesfarmers' willingness to invest in new industries — such as lithium and healthcare — to diversify further and grow earnings. Kmart's Anko brand plenty of growth potential if it can continue expanding overseas.
Pleasingly for shareholders, Wesfarmers is regularly growing its dividend for shareholders, though the dividend yield isn't as appealing right now with the higher Wesfarmers share price pushing it lower.
Over time, the best businesses tend to continue making stronger profits and delivering good returns thanks to their brand power and underlying economics.
I believe Wesfarmers shares can deliver stronger total shareholder returns (TSR) over the next five years than the ASX 200 thanks to its quality and ongoing internal investing.
What are the negatives?
The number one negative that springs to mind is the elevated valuation.
According to Commsec, the Wesfarmers share price is valued at 34x FY24's estimated earnings. Statistics on Commsec show that in FY21 – during the boom of COVID spending and when interest rates were almost 0% — the average annual price/earnings (P/E) ratio was 23.
High-quality businesses typically trade on higher earnings multiples than average businesses, particularly because the best companies demonstrate their outperformance abilities over the long term. However, it is worth noting that Wesfarmers shares are trading significantly above the historical average.
Remember, Bunnings can only open a certain number of warehouses. As it gets bigger and bigger, it could start seeing slower growth. And slower growth should theoretically lead to the market pricing in less growth in the valuation (with a lower P/E ratio).
Households continue to face difficult financial conditions, so I'm not expecting sales growth to surge in the next year or two.
Foolish takeaway
I think Wesfarmers is one of the highest-quality ASX shares that can beat the market over the long term.
However, it doesn't seem great value to me today, and I'd be (pleasantly) surprised if it delivered strong capital growth in the short term.
I'd wait for a better valuation before buying. But, I'd be a very happy shareholder if I already owned Wesfarmers shares because of its operational progress and returns in the last few years.
