Last week, Tesco (LSE:TSCO) shares were the top performing FTSE 100 stock. The share price rose 6.5%, during a week in which the whole index was broadly flat. I think there are a few reasons for this short-term boost for the largest UK supermarket by market share. However, as someone who isn’t already invested in the company, I’m not sure it represents the best buy for me right now.
Reasons for the Tesco share rally
One reason for the boost in Tesco shares in my opinion is the carry-through from its positive Q1 results released a few weeks back. The results showed impressive growth, with like-for-like sales up 8.1% versus two years back. Looking at two years ago gives a fairer pre-Covid comparison.
Customer satisfaction is also ahead of the other supermarkets that make up the Big 4 category. The fact that growth is still being shown and customers are still happy, even though Tesco is already the largest supermarket, impresses me.
I think this helped the rise in Tesco shares last week. After all, not everyone can buy shares immediately after results. Some larger institutional investors take time to analyse in detail and then present a case for investment. So the rise last week could be with some slower-moving investors buying in.
Another reason for the rise is likely due to the bidding situation with Morrisons. It’s been targeted by a private equity company, which sees the supermarket as being undervalued. The Morrisons share price has been surging to reflect the valuation put on it by the private equity suitors.
How does this impact Tesco shares? Well, if the supermarket industry in general is undervalued, that could suggest Tesco should be priced higher. And there’s speculation that Tesco might receive a bid from a private equity company too. We’ll have to wait and see on that, but often a rumour can be enough to cause the share price to rally.
Risk and reward
The top performance last week by Tesco shares is pleasing, but I don’t have a high conviction to buy now.
One reason why I could buy is due to the relatively attractive value when looking at the price-to-earnings ratio. It currently sits at around 19. This looks cheap when I consider that the same ratio for Sainsbury’s is 49 and Morrisons is 73.
However, the figure for Morrisons has been distorted recently due to the steep rise in the share price, so I need to be careful about making decisions based on one ratio.
Another concern I have is that Tesco is by far the largest supermarket in the UK. It has the most to lose to smaller competitors. For example, with Morrisons being bought, I would imagine a large efficiency drive would be carried out. This could include cost-cutting and trying to push revenue higher by the new owners. This could eat away at revenues for Tesco in the process.
Overall, I wouldn’t buy shares in Tesco right now. With all the noise around the industry in general, I’d actually look outside of the supermarket sector to find growth stocks instead.
