Shares in supermarket giant Tesco (LSE: TSCO) have been moving up lately. The Tesco share price has increased by 13% in just under a couple of months and now stands above £3.
The business has a lot going for it: a market-leading position, resilient demand for groceries, and a customer loyalty programme that gives it powerful insights into what shoppers really want.
But, when it comes to the stock market, valuation always matters even for what looks like a strong company. So, at the current Tesco share price, could I find value for my portfolio?
Challenging market with lots of rivals
It can be hard to understand that a business can make huge sales without necessarily turning a big profit.
The grocery market is like that – and Tesco reflects the pattern.
Last year, it made post-tax profits of £1.7bn. That is a lot of money. But doing so required the country’s leading grocer to make £68.2bn of sales. That means it had a net profit margin of under 3%.
The grocery market in Britain is very competitive, with retailers including Aldi and Lidl continuing to expand their store estate. Over time, I see a risk that already thin profit margins will get thinner still.
Tesco is an attractive company
Still, if I ignored valuation for a moment, Tesco seems to have a strong position among the main operators.
It has a large shop estate, ranging from vast hypermarkets to local convenience stores. It has also extensively developed its digital operations. Thanks to its customer understanding due to the loyalty programme, it can build loyalty cost effectively through targeted promotions.
It has a famous brand and, while Aldi and Lidl have upped the ante on low pricing, Tesco can compete against more price-focussed rivals thanks to offering a wider product range and some unique brands unavailable elsewhere.
The shares look like good, not great, value
Still, with a market capitalisation of under £22bn, the FTSE 100 share trades on a price-to-earnings (P/E) ratio of 13.
I would say that offers decent value. The Tesco share price is not a screaming bargain but it offers an attractive valuation for a business of this quality.
That P/E ratio, though, is based on last year’s earnings – and they were the best since before the pandemic. Tesco’s profits have moved around considerably over the past few years.
Having shed assets in recent years, it is now more focussed on its core UK market. I see that as a positive. But I still think the competitive market and price inflation could mean that earnings continue to move around a lot, perhaps downwards.
So, although I think the Tesco share price offers good value, I do not think it is great value.
I am not sufficiently excited by the opportunity to make a move. I would rather wait for what I see as a more compelling bargain to come along.
