I have long believed that the Tesco (LSE: TSCO) share price is one of the most attractive investments in the FTSE 100.
Unfortunately, it doesn’t seem as if other market participants hold the same view. Over the past year, the stock has produced a negative total return of -1.6%. That’s compared to a positive return of 21.5% for the FTSE 100 over the same time frame.
However, I think this could be a great opportunity. After this performance, the Tesco share price now looks cheap compared to the rest of the market. That’s something I want to try and take advantage of by adding the stock to my portfolio.
Tesco share price opportunity
City analysts believe the company will earn 13p per share for its current financial year. Based on these projections, and they are just projections at this stage, the corporation is trading at a forward price-to-earnings (P/E) multiple of 17.6.
That looks expensive compared to the rest of the market. The rest of the market is selling at a median P/E of 15.9.
But I believe the company’s earnings figure is misleading. Tesco’s current financial year encompasses most of the coronavirus crisis. While the organisation has booked significant sales growth during this period, it has also had to spend more on disinfecting its stores, masks for employees, and other initiatives unique to this crisis.
When the pandemic finally comes to an end, these costs should disappear, leading to improved profitability for the group. Indeed, analysts are already forecasting a net profit of £1.5bn for the company’s 2022 fiscal year, up from £942m for 2021 and £971m for 2020. Once again, these are just projections.
Based on these figures for 2022, the Tesco share price is currently selling at a P/E of 11. That looks cheap to the broader market. The stock could also offer a dividend yield of 3.7% this year. That’s slightly above the FTSE 100 average.
Based on these figures, I think the Tesco share price looks cheap compared to its potential.
FTSE 100 investment
The company will only meet these figures if the pandemic fades away in the second half of this year. If it doesn’t, Tesco won’t meet these figures. That’s the most significant risk to my thesis right now.
Another challenge the organisation may face is higher labour costs. These can impact the group’s profit margins and limit its ability to hit City growth expectations. With margins under pressure, the company may also be forced to reduce cash distributions to investors.
Despite these risks, I would buy Tesco for my portfolio today. I think the size of the company gives it a defensive nature, and its sales growth over the past few months is incredibly impressive.
While there will always be a chance the company won’t meet earnings expectations, due to the nature of the group’s business model, I think it’s unlikely (although not impossible), the Tesco share price will inflict significant losses on my portfolio.
As such, I think the risk reward profile of the investment is attractive.
