Pat McKeough responds to many requests from members of his Inner Circle for specific advice on stock investment tips as well as questions on investment strategy and the economy. Every week, his comments and recommendations on the most intriguing questions of the past week go out to all Inner Circle members. And each week we offer you a report on one of the stocks profiled in these Q&A sessions. We give you Pat’s buy-hold-sell recommendation as well as his analysis of the stock. This is part of the specific buy, hold and sell advice we offer you in our daily posts. Every week you get “A Stock to Sell” on Monday, “Best Canadian Stocks” on Tuesday, and “Our Top U.S. Stocks” on Thursday.

This week an Inner Circle member asked us about the biggest retailer of natural and organic foods in the U.S. Whole Foods is the clear leader in its niche market and has expanded beyond the United States with nine stores in Canada and nine in the U.K. Pat assesses the company’s success in tapping into the growing interest in natural foods, its ambitious expansion plans and the state of its balance sheet. He also looks at its ability to improve efficiency and keep prices in line as it attempts to capture a growing share of the increasingly health-conscious baby boom generation.

Q: Hi, Pat. Thanks for your many years of great advice. Could you please give me your thoughts on Whole Foods?

A: Whole Foods Market Inc. (symbol WFM on Nasdaq; www.wholefoodsmarket.com), is the largest retailer of natural and organic foods in the U.S. The company was founded in Austin, Texas, in 1980, when three local businessmen decided the natural food industry was ready for a supermarket format.

Whole Foods sells a selection of perishable foods, mainly natural or organic products, as well as mainstream national brands. Its food comes from all over the world, but it focuses on selling goods from local farmers.

The company operates 399 stores: 381 in the U.S., nine in Canada and nine in the U.K. The U.S. supplies 97% of its sales. In the short term, Whole Foods plans to increase its overall store square footage by 10% a year. Ultimately, it aims to expand to over 1,200 locations in the U.S.

In its fiscal 2014 third quarter, which ended July 6, 2014, Whole Foods’ sales rose 10.4%, to $3.4 billion from $3.1 billion a year ago. Same-store sales—which exclude the eight new stores the company opened in the latest quarter and four others it bought—rose 3.9%.

Earnings gained 6.3%, to $151 million from $142 million. Per-share earnings rose 7.9%, to $0.41 from $0.38, on fewer shares outstanding.

Whole Foods’ balance sheet is strong: it holds cash and investments of $962 million, or $2.65 a share, and its long-term debt is just $60 million.

Whole Foods seeks to offset higher food costs with lower operating costs

Interest in natural and organic foods continues to grow strongly. Whole Foods has also improved its inventory management and cut waste. That’s a big plus for the company, because perishable foods like fruits and vegetables supply two-thirds of its sales.

At the same time, Whole Foods is keeping its prices down, which is helping it appeal to cost-conscious shoppers. The company is also opening smaller stores in areas where rents are lower. Keeping its operating costs low gives it more room to compete with discount retailers like Wal-Mart, which is adding more organic foods to its grocery section.

Even so, higher food costs cut Whole Foods’ profit margin (gross profits divided by sales) to 36.0% in the latest quarter from 36.6% a year earlier. Due to slowing same-store sales and earnings growth, the stock is down to just above $44 from its all-time high of $65.60 in October 2013.

The company is forecast to earn $1.70 a share in fiscal 2015. It trades at 23.5 times that estimate, which is a high p/e ratio for a grocery retailer. However, Whole Foods has a number of important advantages.

For one, it dominates its niche market and has lots of room to expand, particularly outside the U.S. Its strong brand should also help it attract more baby boomers, who are becoming increasingly health-conscious. Moreover, Whole Foods’ new national advertising campaign and loyalty rewards program, as well as upgrades to its e-commerce operations, will likely further spur its growth.

The company pays quarterly dividends of $0.12 a share; the annual rate of $0.48 yields 1.2%.

We currently view Whole Foods as a hold.

Monday we tell you why one Canadian shipping terminal firm may be carrying too much risk.