With shares in Greggs (LSE: GRG) falling by 14% since the turn of the year, many investors may feel that the company is worth buying. After all, Greggs now offers better value than at the start of the year and with its transformation programme being on track and yielding good results, it could have a bright long-term future.
The problem, though, is that Greggs still trades on a rather high valuation. It has a price-to-earnings (P/E) ratio of 19.3 and with its bottom line due to rise by a lowly 2% this year and by a further 8% next year, its shares could realistically come under further pressure.
A key reason for this is that the UK economy is undergoing a period of major change. Wages are rising at a faster rate than inflation and with deflationary pressure likely to remain in play across the world economy, this situation could persist over the medium term. And while Greggs has been popular when consumers were somewhat cash-strapped, their tastes may evolve towards greater quality and convenience, with price and value having the potential to become less important.
As such, Greggs may find demand for its products comes under pressure and its share price could be hurt further as a result.
Enticing risk/reward ratio
Similarly, Sports Direct (LSE: SPD) has been a popular place to shop for consumers who have experienced significant pressure on their disposable incomes over a sustained period. However, it may also struggle to grow sales as quickly as in the past and with its international operations offering mixed results, investors may feel that Sports Direct is doomed to fail.
However, unlike Greggs, Sports Direct offers a relatively wide margin of safety. For example, it trades on a P/E ratio of just 10 and this indicates that its shares may have limited downside and considerable upside. That’s especially the case since Sports Direct is forecast to increase its earnings by 8% in the next financial year. And while its sales performance could disappoint in the short run, it seems to offer a sufficiently enticing risk/reward ratio to merit purchase right now.
Long-term strength
Meanwhile, Tesco (LSE: TSCO) continues to face a UK supermarket scene that’s extremely competitive. However, an improving outlook for the UK consumer could aid the company since it may mean that shoppers become less price-conscious and instead consider convenience, customer service and choice to a greater extent. With Tesco arguably being stronger on such areas than many of its no-frills rivals, its sales and profitability are set to rise over the medium term.
In fact, Tesco’s earnings are due to rise by 39% in the next financial year and this puts it on a price-to-earnings growth (PEG) ratio of just 0.5. Therefore, it’s the cheapest of the three companies discussed here and this indicates that it may have the most capital gain potential. Certainly, Tesco needs more time to make asset disposals and deliver on its wider strategy, but it has made an excellent start and now could be a sound opportunity to buy it for the long term.
