Tesco’s (LSE: TSCO) share price surged this week after the FTSE 100 giant released full-year results for FY2017. While the stock still has a fair way to go to get back to the levels it was trading at five years ago, over the last year it is up almost 30%. As one of the most recognisable names in the FTSE 100, is it a good idea to buy Tesco shares for a starter portfolio?
Turnaround
Tesco’s FY2017 results suggest that the company is slowly turning things around. For the year, group sales increased 2.3%, while group operating profit before exceptional items rose 28%. The company managed to reduce its net debt by 30% and chief executive Dave Lewis stated: “This has been another year of strong progress, with the ninth consecutive quarter of growth. More people are choosing to shop at Tesco and our brand is stronger, as customers recognise improvements in both quality and value.”
So does that make Tesco a good stock to buy? Let’s look at the valuation and dividend yield.
City analysts currently expect Tesco to generate earnings per share of 13.5p this financial year. At the current share price, that places the stock on a forward-looking P/E of around 17. In my opinion, that valuation looks a little high, given the fact that the landscape for the supermarket sector is likely to remain challenging due to competition from the German discounters. The average forward P/E for the whole FTSE 100 index is 14 right now. Personally, I don’t think Tesco deserves a higher valuation than that.
Tesco’s dividend yield also looks rather underwhelming. The company has declared a payout of 3p per share for FY2017, which at the current share price, equates to a yield of under 1.5%. I could pick up a similar yield from a cash ISA. I don’t see a lot of dividend appeal here, even if the payout is forecast to rise significantly this year.
Weighing up these factors, I don’t believe Tesco is the best buy for a starter portfolio at present. There are plenty of other FTSE 100 stocks that are trading at bargain basement valuations, such as Lloyds Bank, or Legal & General Group, that I would be inclined to buy before Tesco.
One stock I would buy
One stock that I do believe would make an excellent addition to a starter portfolio is FTSE 100 financial services group Aviva (LSE: AV). It has strong operational momentum right now, with City analysts upgrading their earnings forecasts for this year and next, yet its shares remain cheap and the dividend yield looks compelling.
Analysts expect Aviva to generate earnings of 57.1p per share this year. At the current share price, that places the stock on a forward P/E ratio of just 8.8. That valuation simply looks too cheap to me. I believe there’s scope for a re-rating.
Similarly, Aviva’s dividend yield jumps out at me as highly attractive. The company lifted its dividend by 18% last year, to 27.4p per share, which at the current share price, equates to a fantastic yield of 5.5%. Analysts expect the dividend to keep growing in the next few years, and there’s also the potential for special dividends too, which means that Aviva could turn out to be a serious cash cow for investors.
Given the lower valuation and higher yield, I would pick Aviva over Tesco for a starter portfolio.
