While the Tesco (LSE:TSCO) share price is up 27.6% over 12 months, it’s only risen 1.3% over two years. As we can see from the below chart, the Tesco share price dipped a year ago, brought on by the cost-of-living crisis and Liz Truss’s disastrous economic plan. It was a short-lived slump.
So, what’s behind the improving share price, and could we possibly see Tesco shares double next year?
The market leader
Supermarkets operate in a fiercely competitive industry, where numerous players vie for market share.
In a low-margin environment, supermarkets rely on economies of scale and efficient supply chain management to drive down costs and increase operational efficiency.
Thanks to its economies of scale and industry positioning, Tesco enjoys a competitive advantage in the retail space, constituting approximately 86% of its sales.
And Tesco is by far the largest UK supermarket, with 27.5% market share. This is down marginally over the last decade, but there appears to have been no material impact from the cost-of-living crisis and the entry of low-cost competitors Aldi and Lidl.
However, during the cost-of-living crisis, and amid an increasingly competitive market, its economies of scale have provided a competitive edge, and its diversified business allows it to absorb lower retail margins effectively. It has a dominant position.
As such, along with Marks and Spencer, it’s among the best performing supermarkets this year.
Growth and value
Tesco broadly trades in line with its peers at 12.4 times earnings. However, the market leader is expected to experience an analysed growth rate of 25.5% over the medium term (three-five years).
In turn, this leads to a price-to-earnings-to-growth (PEG) ratio of 0.49, making it the cheapest stock on the index using this metric. This is incredibly low.
I like the PEG ratio because it combines a stock’s price-to-earnings ratio with its earnings growth rate. It, therefore, offers a comprehensive assessment of valuation and growth potential.
Calculated by dividing the price-to-earnings ratio by the earnings growth rate, a PEG ratio below one suggests potential undervaluation.
This method provides a more nuanced approach, helping me gauge investment opportunities that align with my portfolio goals.
In turn, a PEG ratio of 0.49 suggests that Tesco could be undervalued by as much as 51%. Theoretically, Tesco shares, according to this metric, could be trading around £5.90 — double the current position.
My take
Tesco has seen some gradual drop off in market share over the past decade, falling from around 30% to 27.5%. That could be seen as a concern.
However, Tesco remains in a commanding position, and that’s important in a high volume market, allowing it to leverage economies of scale to out-price peers.
Moreover, I think it’s also true to say that shoppers may migrate towards Tesco and away from budget alternatives as the economic situation improves.
I’m yet to buy Tesco shares, but given the above, I’m looking to do so when I have the capital available.
