Are Coles or Woolworths shares a better buy right now?

Which of these supermarkets is the right choice to go shopping for?

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Supermarket giants Woolworths Group Ltd (ASX: WOW) shares and Coles Group Ltd (ASX: COL) shares are both viewed as defensive because of the essential nature of what they sell. We all need to eat, after all.

Supermarkets have an extremely consistent level of demand each year, and the number of mouths to feed in Australia continues to grow. According to the Australian Bureau of Statistics (ABS), Australia's population recently reached 27.5 million, and it could reach 30 million in the early 2030s. That's a useful growth tailwind.

In my mind, investors don't necessarily need to own both supermarket businesses individually in their portfolios because the two are so similar. So, which one is the better choice? I'll run through three of the things that would help me decide.  

Valuation

When two companies are from the same industry, it's easy to compare their valuations based on the price/earnings (P/E) ratio, also known as the earnings multiple.

The market typically values businesses based on future earnings rather than past profit generation. I'm going to use analyst forecasts to determine each business's FY25 P/E ratio.

UBS projects Coles could generate earnings per share (EPS) of 83 cents in FY25, putting the company's share price at 23x the projected profit for the 2025 financial year.

Turning to Woolworths, UBS said that the 17 days of industrial action in December last year cost Woolworths $140 million in sales and between $50 million to $60 million in operating profit (EBIT). Due to that, UBS recently reduced its Woolworths EPS forecast for FY25 by 3.7% to $1.22. That means the Woolworths share price is now valued at 24.5x FY25's estimated earnings.

Coles shares look slightly cheaper, but there's not much in it.

Dividend yield

While dividends aren't everything, they can be a very useful boost for returns and can play an important role in an investor's passive income needs.

Impressively, Coles has grown its dividend each year since it started paying a dividend in 2019. The forecast from UBS is for a dividend of 72 cents per share, which translates into a grossed-up dividend yield of 5.4%, including franking credits.

Woolworths cut its dividend in 2022, so it hasn't been as consistent. It's projected to pay a dividend per share of 92 cents in FY25, translating into a grossed-up dividend yield of 4.4%, including franking credits, at the current Woolworths share price.

Coles clearly offers a higher level of passive income if that's a focus for investors.

The two companies are pursuing somewhat different strategies, in my view.

Coles is really focusing on being the best supermarket business it can be. It's investing significantly in its distribution and logistics facilities. The Witron automated distribution facilities in NSW and Queensland are helping with product freshness, availability, efficiencies, and costs. The new Ocado customer fulfilment centres (CFCs) can help with a stronger online offering for customers.

UBS notes that Coles is targeting at least 1.5% store space per year, with at least 14 new stores per annum and 60 renewals per year.

According to UBS, cost control is a key focus for Woolworths. The broker said:

Looking forward, cost control is a key focus for investors following a period where cost was less of a focus, with specific opportunities across online, new adjacent businesses & overhead, as well as the ongoing productivity focus across stores & DCs.

I think it's interesting that Woolworths is targeting more areas than Coles, including business-to-business sales, pet products, retail media and general merchandise (with Big W). Will that diversified approach work or is Coles' focused approach a better play?

My pick is Coles, I like its efforts to invest in technology and unlock better performance. Coles shares look better value, with a better yield, compared to Woolworths shares.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Coles Group. 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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