This is a great example of why investors need to watch the business and not the stock price.
In August 2013, grocery store chain Sprouts Farmers Market (SFM 2.83%) went public with an initial public offering (IPO). At the time, a Forbes headline called it the “Best IPO Debut Since LinkedIn” as shares more than doubled on the first day of trading, closing at around $40 per share. For context, LinkedIn was a high-profile tech IPO in 2011, making Sprouts the most exciting IPO stock in multiple years.
I’m sure investors were riding an emotional high with Sprouts stock after a market debt like that. But exactly 10 years later, it traded at about $38 per share. In short, Sprouts stock went absolutely nowhere for a decade and was trounced by the returns for the S&P 500.
SFM data by YCharts.
If you gave up on Sprouts stock sometime during the decade, you can be forgiven — after all, chronic under-performers usually continue to disappoint shareholders. But not in this case. Shares of Sprouts are now up roughly 200% in the little more than one year since it hit its 10-year milestone as a publicly traded company.
After a decade of futility, Sprouts has suddenly tripled in value in slightly more than a year. Here’s why.
Why Sprouts is one of the market’s hottest stocks
Sprouts Farmers Market is a chain of grocery stores with 415 locations as of the second quarter of 2024, specializing in fresh produce and healthier-for-you packaged products. In the first half of 2024, the company’s revenue was up 10%. Its operating margin during this time was 7%.
Those are good numbers for a grocery stock. But the surprising thing here is that these numbers aren’t uncharacteristically good for Sprouts. On the contrary, the company has regularly grown its revenue by a double-digit rate since going public in 2013. Moreover, its operating margin is often much better than many of its grocery peers’.
The fact is that the business fundamentals have consistently improved for Sprouts over the past decade, but investors didn’t seem to care. Over time, its valuation got cheaper and cheaper as its financials went up and its stock price didn’t. Slowly but surely, management took advantage of the cheap stock price by repurchasing shares.
Over the long term, Sprouts’ share count is down, and its earnings per share (EPS) are up. Companies that have charts like this usually perform well eventually, and investors seem to finally be waking up to the good things happening with Sprouts.
SFM EPS Diluted (TTM) data by YCharts.
But why now and not before? For that, I don’t have a good explanation. The truth is that the stock market isn’t always rational, contrary to conventional wisdom. Because of this, a stock such as Sprouts can inexplicably go sideways for many years before its business growth is finally rewarded with a higher stock price.
Sprouts’ moment finally came. I think it’s an important lesson in investing: The business fundamentals tend to win over the long haul. But sometimes investors have to exercise extreme patience, as was the case here.
Can Sprouts stock keep winning?
Over the next few years, Sprouts Farmers Market intends to open more than 100 new locations of its grocery chain. With just a hair over 400 locations today, that’s a meaningful increase.
Investors can expect revenue to grow for Sprouts with these new locations. Same-store sales growth can provide another avenue for revenue upside. Management expects 4% to 5% year-over-year growth this year. Assuming similar growth in future years, the company could realistically grow revenue at a double-digit rate for several more years, at least.
Turning to profits, Sprouts’ operating margin is pretty high right now. It could trend modestly lower. But since going public, the company has always generated positive operating income on a trailing 12-month basis. It’s reasonable to assume its profitability could continue and increase from here.
Another under-appreciated trait of Sprouts is that it’s now debt-free — not only has the company been increasing shareholder value by repurchasing shares, it’s paid off these obligations. To me, this makes this stock a safer investment than before.
I wouldn’t necessarily expect the stock price to triple again over the next year. But Sprouts stock can rise with ongoing growth. It could go sideways for a time — it has in the past. But if shareholders can wait patiently, the improving business fundamentals should eventually lift shares higher. And with strong profits and no debt obligations, investors are in a safer position to buy and hold patiently for the long term.
Jon Quast has no position in any of the stocks mentioned. The Motley Fool recommends Sprouts Farmers Market. The Motley Fool has a disclosure policy.
