Market overreaction from Amazon buying Whole Foods

The news of Amazon buying Whole Foods is nearly two months old. The deal is valued at $13.7bn, representing a 27% premium to Whole Food’s closing price.

When the news was announced, the stocks of traditional grocery stores were clobbered. Walmart tumbled 5%, Target -5%, Kroger -9%, Dollar Tree nearly -4%, Dollar General -3%. Roughly $22 billion of market value from grocery-related stocks vanished in one day. That’s more than the acquisition value of Whole Foods.

The concern is on competition. Amazon is well-known for competing on margin. Its entry into traditional grocery business may force others to cut prices and squeeze the profit margins. Therefore, many sold these grocers in panic.

“Be greedy when others are fearful” – Warren Buffett.

With some courage, I bought at dip. I bought back Dollar General at 70.75 on that day. My last trade on DG was selling it at 77.95 in February 2017 (see this post). Since selling it, DG actually did better than the market expected. After Q1 earnings release, its stock spike 6.5% before falling back and getting further hit by Amazon and Whole Foods deal.

Since the news of that acquisition, the share prices of these grocers have mostly recovered. From 16 June until today, Dollar General’s stock has risen by 9.5%, Dollar Tree +8%, Target +12%, Walmart +8%, Kroger +9%. For the same period, S&P 500 rose by only 2.2%. Therefore, the recovery of these grocers’ share prices were not due to general market movement, but due to industry specific movement. The buy at dip strategy turns out to be good (so far).

In this case, we did not really need to buy on that day of the deal. As it turned out, the prices of these grocers continued to trade at low end for nearly one month after that deal. Thus, many investors who missed the news and dip could still jump in later at the similarly low price.

This activity of buying during panic selling does not always work, and most investors are advised to stay away from it as they might end up catching a falling knife. However, you can turn it into an advantage when you have a sense of value. If you know the value of a company (estimated based on analysis and established method), and its share price suddenly plunged in what you considered a panic/irrational selling, you could buy at dip provided that the price is below your estimated value range. In this way, the Mr. Market is your friend.

In order to take advantage of the opportunity of panic selling, first, it takes lots of time and effort to do the hard work of studying many companies and estimate their value. Second, it takes discipline to buy only a handful of those you see more reward than risk. You should understand that many of the research will end up with no activity. Third, it takes lots of patience to wait for the right price. Those no-buy can turn into a buy only when the price is right. Sometimes the right price never comes and much of your research effort goes into drain. It’s part of the game.

I consider Dollar General fairly valued at around 70-80. Hence, when the price fell to 70 during panic selling, I thought it’s at the low end of the fair value range and felt comfortable buying. If the recovery from panic selling did not happen, I’m comfortable holding it for a longer period.

Now, many of these grocers will report their quarterly earnings from mid to late August. Volatility is expected. As for direction, I’m clueless.