Would I be bonkers to buy shares in Tesco right now?

Why I reckon something fundamental has changed about Tesco plc (LON: TSCO), and what I’d do now.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Something fundamental has changed about Tesco (LSE: TSCO) over the past few years.

There was a time when many investors considered the supermarket sector to be defensive and cash-generating. Ideal for supporting a stream of dependable dividends.

But if Tesco was ever a sleep-well-at-night investment, it caused shareholders to fall out of bed with a bump around six years ago when it suffered a profit, dividend and share-price collapse.

Old assumptions out the window

Out the window went all those previous assumptions about Tesco and the supermarket sector in general. Instead of being safe and reliable, Tesco revealed its true colours as a low-margin outfit operating in a sector characterised by cutthroat competition. The Tesco empire had been built on sand and it didn’t take much to make it wobble, just a nudge or two from disrupting competitors Aldi, Lidl and others in the UK.

The firm didn’t generally fare well abroad either and has been unwinding its overseas operations. Indeed, customers can be fussy, and they have plenty of choices. If Tesco doesn’t give people what they want, they vote with their feet and shop elsewhere. The business model strikes a fine balance, I reckon, and it doesn’t take much to upset things.

However, under chief executive Dave Lewis, the firm has been turning itself around. For a while, those numbers for growth in earnings looked impressive at 29%, 42%, 45% and 38%, for example. But the revenue figure is more or less back to where it was in 2014, and I reckon a firm can only go so far when it comes to squeezing efficiencies and profits out of an enterprise. Indeed, the forward-looking growth figures for earnings are less impressive at 6%, and 10%. I’m not expecting a return to double-figure advances any time soon, or ever.

A new problem

Now there’s a new problem with Tesco, as I see it. The valuation is far too rich. The recent share price close to 235p throws up a forward-looking price-to-earnings (P/E) ratio for the trading year to February 2021 of just under 13 and the anticipated dividend yield is just below four. My view is that the firm’s business is in long-term decline, so I’d want a yield of at least 5% to compensate me for holding the shares in the face of the many risks ahead.

But Tesco also fails a basic test I like to apply: is the share capable of outperforming its index, in this case, the FTSE 100? My view is that Tesco seems unlikely to soar ahead of its index in the years ahead but it still has exposure to all the downside risks of its sector. So in this case, I’d rather invest in a FTSE 100 index tracker fund than take on the individual-company risk of holding Tesco shares.

To me, there are better strategies than buying the shares of firms that have recently demonstrated their ability to fail in some way. So I reckon I’d be bonkers to buy Tesco shares right now.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Kevin Godbold has no position in any share mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Businesswoman calculating finances in an office
Investing Articles

Could me buying this stock with a $2.5bn market-cap be like investing in Tesla in 2010?

Archer Aviation (NASDAQ:ACHR) stock's nearly doubled so far in November. Could this start-up be another Tesla in the making?

Read more »

Investing Articles

5,000 shares of this UK dividend stock could net me £1,700 a month in passive income

Our writer calculates the passive income he could earn from holding a significant number of shares in this powerful dividend-paying…

Read more »

Investing Articles

9.3%+ yields! 3 FTSE 100 dividend giants to consider buying

Our writer examines a trio of high-yield FTSE 100 shares and explains some of the opportunities and risks he sees…

Read more »

Investing Articles

As the Kingfisher share price drops on Budget fallout, should I buy?

The Kingfisher share price was on a strong 2024 run until the DIY group warned us of the possible effects…

Read more »

Investing Articles

2 passive income shares to consider for December 2024 onwards?

These are popular UK shares investors often buy for passive income from dividends, but are they actually good investments now?

Read more »

Young black woman using a mobile phone in a transport facility
Investing For Beginners

Down 34% in a month, is this FTSE 100 stock going to be demoted?

Jon Smith flags a FTSE 100 company with a recent poor performance he believes could see it soon drop out…

Read more »

British union jack flag and Parliament house at city of Westminster in the background
Investing Articles

Is the Diageo share price set to make a stellar comeback in 2025?

Harvey Jones thought the Diageo share price looked good value when he bought it after last year's profit warning, but…

Read more »

Investing For Beginners

It’s down 50%. Would it be madness for me to buy this value stock?

Jon Smith notes down a household value stock in the FTSE 250 that he thinks can rally in the long…

Read more »