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Cramer Compares SuperValu, Whole Foods Market

Monday, 14 Nov 2011 | 6:57 PM ET
Some Cheap Stocks are too Expensive
Could an $8 stock be more "expensive" than a $67 stock? Mad Money's Cramer, takes a look at two stocks in the same sector; SuperValu and Whole Foods, and shows investors why it's important to take the stock's growth rate into account by looking at the PEG ratio when comparing price.

Cramer on Monday compared and contrasted SuperValu and Whole Foods Market to determine which has the cheaper stock.

SuperValu is an $8 stock that trades at 6.5 times forward earnings. It seems cheap considering the average stock in the S&P 500 index trades at 12 times earnings. Whole Foods , on the other hand, is a $68 stock that trades at 26 times forward earnings. Although it may appear SuperValu is the least expensive name, Cramer said Whole Foods is actually the cheap one.

How could this be? First, Cramer reminded viewers that the share price means nothing. Investors should look at the price-to-earnings multiple for a true comparison of which stock is least expensive. The price-to-earnings multiple, by the way, can be computed by taking the stock price and dividing it by next year's earnings estimates, as calculated by Wall Street analysts. The stock with the lowest multiple isn't always the cheapest stock, though.

"When we're valuing stocks, we have a specific metric that compares the price to earnings multiple to the growth rate—it's called the PEG ratio, and it's critical to understanding just how cheap or expensive a stock truly is," Cramer explained. "To figure out the PEG ratio, you divide the multiple by the growth rate. It's that simple."

So SuperValu has a 1.8 long-term growth rate while Whole Foods has an 18 percent growth rate. When growth is factored in, SuperValu has a PEG of 3.48 and Whole Foods has a PEG of 1.44. So here we see that Whole Foods can be a lot cheaper than SuperValu.

"Remember, we don't care about the dollar amount of a stock price," Cramer said. "In this business it's perfectly reasonable that an $8 stock is much more expensive than a $68 stock, especially when the latters' growing and the former's just stuck in the mud."

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