Tesco’s (LSE: TSCO) share price has gained around 26% since its 11 July 12-month traded low of £2.45.
This sort of rise might put some investors off, thinking the stock is too expensive now. Others may feel compelled to jump on the bandwagon and buy it, for fear of missing out.
In my experience, neither is an approach that will consistently make money in long-term investing.
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For me, the only question is whether the shares still have value left in them. If they do, then I will examine whether they fit my other investment criteria.
Do the shares still offer value?
Tesco currently trades on the key price-to-earnings ratio (P/E) measurement of share valuation at 12.1. This compares to its peer group average of 23.7, so it looks cheap on that basis.
To ascertain how cheap, I ran a discounted cash flow analysis to find out its fair value. This shows Tesco shares are 32% undervalued on this measure, despite the rise in price over the year.
So, with the shares currently at £3.09, a fair value would be about £4.54.
This is not to say the shares will necessarily reach that level. But it does signal to me that they could still be a major bargain at the current level.
Strong business outlook?
Like most of the big grocery operations in the UK, the cost-of-living crisis affected Tesco’s business. Inflation and interest rates still look to be coming down, but a resurgence in them is a primary risk for the company.
Another is the growing presence of the budget grocers Aldi and Lidl, in my opinion. And there remains the ongoing threat to business share from Tesco’s historical rivals, Sainsbury’s, and other traditional supermarket chains.
Having said that, its Q1 trading statement released on 14 June showed its market share growing to 27.6%. This is still the top spot, ahead of Sainsbury’s at just over 15%.
Interesting to me in terms of the budget supermarket threat is that it remains the cheapest of the major grocers. This has been achieved through a direct ‘Aldi Price Match’ initiative on around 700 lines, plus ‘Low Everyday Prices’ campaigns.
Tesco maintains its full-year guidance of at least £2.8bn in retail adjusted operating profit. It also projects retail free cash flow of £1.4bn-£1.8bn.
Consensus analysts’ estimates are now that earnings will rise by 3.2% a year to end-2027. Return on equity is forecast to be 17.8% by that point.
Will I buy the shares?
Over 50 now, I am focusing on high-dividend paying shares so I can continue to reduce my working commitments.
Tesco’s dividend of 3.9% is way off the 8.5%+ average of my core high-yield holdings. So I cannot justify my buying it on that basis right now.
However, this is likely to rise over time as the firm continues to grow. From 2025 to 2027, consensus analysts’’ estimates are that the yield will rise to 4.1%, 4.5%, and 4.8%, respectively.
I also think the firm is in a good position to retain its leading market position, which should power growth. This, in turn, should also drive share price gains, in my view.
So, if I were at an earlier stage of my investment life I would definitely buy.
