Here's why I prefer Coles shares to Woolworths right now

It's Woolworths I'd vote down down rather than Coles shares today.

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Coles Group Ltd (ASX: COL) and Woolworths Group Ltd (ASX: WOW) are two halves of one of the most intense corporate rivalries in Australia. Both Coles shares and Woolworths shares compete on the ASX for investors, of course. But these two companies form two halves of what is close to a duopoly in the grocery and supermarket space.

When it comes to groceries, Woolworths is the clear winner. As we looked at last month, Woolworths was able to nab a 37.1% share of the Australian grocery market in FY2022, while Coles came in a distant second, with a 27.9% share.

Often, investors like to put their money into the most dominant company in an industry, surmising that what got a company to the number one spot is likely to keep it there.

But in this case, I disagree. I would pick Coles shares as a buy today over Woolworths shares. And enthusiastically so.

Why are Coles shares a better ASX buy than Woolworths?

For what it's worth, I think Woolworths is a slightly better business than Coles. It hasn't achieved market dominance for nothing and I think the company has benefitted from superior marketing, operations, and brand management.

However, those advantages do not make up for the biggest problem I see in the Woolworths share price today: its valuation. Put simply, I think Woolworths shares are far too expensive for what they offer investors.

To illustrate, let's analyse Woolworths' price-to-earnings (P/E) ratio. At the present time, Woolies trades on a P/E ratio of 27.4. This means that investors buying shares are being asked to pay $1 for every $27.40 Woolworths makes in earnings.

That is quite high by ASX standards. None of the big four banks, for example, trade on anything close to a P/E ratio of 27.4. Nor do the miners like BHP Group Ltd (ASX: BHP) or Rio Tinto Limited (ASX: RIO).

But P/E ratio norms differ from sector to sector, so let's check out what Coles is trading at.

As it stands today, Coles shares have a P/E ratio of 21.19. Coles and Woolies' far smaller rival, IGA-owner Metcash Limited (ASX: MTS) is sitting on just 14.10.

This means that Woolworths is trading at what is almost a 30% premium to Coles shares, and almost double that of Metcash. Incidentally, it's about the same as Google-owner Alphabet's P/E ratio at present.

Woolworths is an expensive buy

Now, if we agree Woolies has a slightly superior business model to that of Coles, it could justify perhaps a 10% premium in valuation, or even 15%. But 30%? That's not a deal I'm tempted to make.

The fact that Coles' valuation is so much cheaper than Woolies has several spillover effects. For one, it gives the Coles share price a far stronger buffer for any stock market crash-induced pricing slump when the inevitable next stock market crash rolls around. This arguably makes Coles a better defensive share.

But perhaps more importantly for ASX investors, it means that Coles shares offer a far higher dividend yield than Woolworths today. Right now, Woolworths shares offer a trailing dividend yield of 2.6%. Coles, on the other hand, has a dividend yield of 3.68% to tempt investors.

If Woolies traded at the same P/E ratio as Coles does right now, its dividend yield would be far higher. But as it stands today, Coles is the clear winner when it comes to income.

Thus, Coles would easily be my pick of the two ASX grocery giants if I had to choose one today.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Motley Fool contributor Sebastian Bowen has positions in Alphabet. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Alphabet. The Motley Fool Australia has positions in and has recommended Coles Group. The Motley Fool Australia has recommended Alphabet and Metcash. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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