Sell Whole Foods, Hold Starbucks, Buy Coke and Pepsi

NEW YORK (TheStreet) -- Is it me or does it seem as if a lot of air has suddenly been let out of the market following the disappointing quarter by one of its darlings, Chipotle (CMG)?

While it came as a surprise to most, it should not have been the bombshell many are making it out to be. If one took time to carefully study the stock, it could have been seen a mile away -- or at least a couple of days ahead of the report.

Investors want to know what it means for other food and beverage stocks.

In this article we are going to discuss the investment-worthiness of four stocks within the sector that have been affected by the Chipotle disappointment and see if they deserve cautious market activity or if it's just a slight overreaction. I happen to think that it just might be a bit of both.

While there are some good buying opportunities in the traditional food/beverage powers in Coca-Cola ( KO) and Pepsi ( PEP), I think it would be wise to hold tight on coffee giant Starbucks ( SBUX) while reducing exposure to Whole Foods ( WFM).

Let's take a look at my arguments and see if you agree.

Sell Whole Foods

First and foremost, I have to be completely honest and admit that this continues to be one of the toughest calls for me to make -- placing a sell recommendation on a company that not only has a fundamentally sound business but, equally important, a pleasant fundamental mission in healthy living. So what exactly is the problem?

When it comes to Whole Foods, the challenge for me has been its stock price, too expensive for my taste. The market, however, has had different ideas for quite some time now. Investors can't seem to get enough, and in many respects the stock had developed the same appeal as Chipotle where valuation metrics have become unimportant.

With that in mind, in light of Chipotle's recent earnings, it seems prudent to take a serious look at where things have been and where they may be heading for Whole Foods. Aside from Apple ( AAPL), not many stocks have performed as well as Whole Foods over the past five years to the extent of a 90% increase including gains that at one point reached as high as 30% on the year.

However, as a value investor and, more importantly, one who also appreciates some margin of safety, coming to terms with a stock that is trading at 38 times earnings continues to be a challenge that is just too much to overcome.

Will the company demonstrate in its upcoming report that it deserves its valuation or will its numbers remind investors that perhaps too much exuberance has been added?

Analysts are expecting earnings per share to arrive at 61 cent on revenue of $2.73 billion. Although the company has beaten estimates in each of the past four quarters, including its second-quarter report where it beat estimates by 5 cents, it would not come as shock here to see a miss.

Though the company has demonstrated that it can continue to grow despite severe economic concerns, I think the smart thing to do here is to sell ahead of earnings which are due out Wednesday after the bell.

Hold Starbucks

I have been a bull on Starbucks all year. In fact, two weeks ago I made a case for why I thought it was significantly discounted relative to other food and beverage stocks, in particular Chipotle. I think you see where this is going. Will its upcoming report justify its valuation which sports a price-to-earnings ratio of 30?

At present, Starbucks has more than 17,000 cafes around the world and recently said it will accelerate new-store growth this year to approximately 1,000 net new stores globally. Similar to Chipotle, it is clear that it expects to grow into any valuation permitted by heavily expanding customer traffic. But at what cost?

In its recent earnings report the company demonstrated precisely what a coffee addiction should look like as it provided an 18% jump in its revenue. Even more remarkable is that its global revenue also continues to increase to the tune of 7% at locations that have been opened for at least one year.

This is an indication the company benefited not only from an increase in foot traffic, but customers were paying more per visit. However, this was in its second-quarter report. Chipotle also demonstrated similar growth. For Starbucks' third-quarter, analysts are expecting earnings per share of 46 cents on revenue of $3.33 billion, although recently management guided somewhat lower to a range of 44 cents to 45 cents.

The company remains an excellent growth story and certainly should be a part of a long-term portfolio. However, on the heels of Chipotle's poor performance logic says caution should be the best approach here with Starbucks. Though I would not recommend selling the stock, neither would it be prudent to add ahead of its report.

Buy Coke and Pepsi

While these two titans have battled it out in the market for years with their legendary "taste test," they both have been safe stocks by virtue of their stability, market-beating performance as well as continuing to offer one of the best dividend yields on the market.

Last week, upon the release of Coca-Cola's earnings report, investors were once again reminded not only why the company continues to be one of the best brands in the world, but also a standout in terms of execution.

For the second quarter, Coca-Cola reported net income of $2.8 billion on revenue of $13.1 billion, topping analyst expectations both on the top and bottom lines. The company attributed the solid performance on overseas growth in areas such as China, Russia and India. On the year the stock is up over 11%, with no noticeable signs of slowing down.

As for PepsiCo, the company will report earnings on Wednesday and investors should expect similar to or slightly better results than Coke.

Analysts expect the balance of 2012 to generate total sales of $67.5 billion and earnings of $4.11 per share, or 2.4% growth. It gets even more interesting for 2013, where that number is projected to top $70 billion with sales growth of 4.5% on earnings of $4.44 per share.

As both companies demonstrate similar strengths and challenges, the difference comes from their respective growth prospects or, more appropriately, which one is better positioned to capture and maintain what is left of the market.

From the standpoint of valuation that places PepsiCo at forward trading multiples of 16 for this year and just under 15 for 2013 based upon its current valuation.

Coca-Cola currently trades at a price-to-earnings ratio of 20 and its growth projections places its forward P/E at just under 18.

The numbers clearly demonstrate how tight the race is between these two rivals as they are both heading in the same direction -- upward, which makes them both excellent long-term buys.

Bottom Line

Earnings season can be both an exciting time as well as one that brings a lot of anxiety for companies as well as investors. It's called the reporting period for more than one reason: Companies are essentially sharing their quarterly report cards, where getting a passing or failing grade often depends on the expectations that were set.

In a separate article, we'll look at possible earnings plays in Facebook ( FB), Amazon ( AMZN) and Exxon Mobil ( XOM).

At the time of publication, the author was long AAPL and held no position in any of the other stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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