As the Tesco share price stays cheap, I’d invest £5k

The Tesco share price is still low and the stock has potential as a recovery investment, argues this Fool who’s willing to invest today.

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I reckon investing in the UK’s largest retailer could be an excellent way to ride the country’s economic recovery. The Tesco (LSE: TSCO) share price has bounced up and down over the past 12 months. Despite the retailer’s impressive performance throughout the pandemic, rising costs have weighed on profitability.

What’s more, the company refunded the benefit it received from the government business rate cut. These cuts disproportionately benefited Tesco and its supermarket peers, so returning the money, after a bumper year, seemed the right course of action. 

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Unfortunately, the decision to return the cash now means Tesco will report depressed profits for two years in a row. For its 2019 financial year, the firm reported a net income of £1.3bn. This figure fell to £971m for 2020. Analysts are forecasting a net profit of £941m for the group in fiscal 2021. 

Tesco share price outlook 

The good news is that City analysts don’t expect this trend to continue indefinitely. Analysts have already pencilled in a recovery for Tesco’s 2022 financial year. The City currently believes group net income will rise to nearly £1.5bn in fiscal 2022.

Based on these projections, the stock is trading as a forward P/E of 11. I think this seems cheap compared to the stock’s five-year average P/E of around 15. 

I should caution that these are just estimates at this stage. There’s no guarantee the supermarket group will hit this level of profitability. However, I believe it shows the company’s potential.

Over the past five years, the company has gone through a tremendous transformation. It has sold off non-core, underperforming businesses and doubled down on its offer here in the UK. Initial indications seem to suggest this strategy is paying off. 

After the group’s accounting scandal, management set out several key goals to judge Tesco’s turnaround. One of these was for the organisation to achieve a 4% operating profit margin. 

The company hit this target in 2019, and the Tesco share price reflected this progress. Then the pandemic arrived, and Tesco was forced to take a defensive stance. 

Return to growth 

As the UK economy recovers from the pandemic, I think it’s likely to return to growth. Investors may see the full benefits of management’s efforts to turn the business around over the past five years. 

Of course, this isn’t guaranteed. The pandemic could continue to rumble on for several years. The UK grocery sector is also incredibly competitive. Tesco has only managed to gain an edge over its competitors by investing significant sums in its UK business.

If it takes its eye off the ball, rivals could quickly steal market share. Other challenges, such as rising wage costs, may eat away at the group’s profit margins and bottom line.

As such, while I’m optimistic about the outlook for the Tesco share price, I’m aware the group faces many challenges. Nevertheless, I think the business can overcome these challenges, as it has done in the past. That’s why I’d invest £5k in the stock today. 

Alongside Tesco, I would also buy a diverse portfolio of UK growth shares, like the company outlined in the report below.

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And the performance of this company really is stunning.

In 2019, it returned £150million to shareholders through buybacks and dividends.

We believe its financial position is about as solid as anything we’ve seen.

  • Since 2016, annual revenues increased 31%
  • In March 2020, one of its senior directors LOADED UP on 25,000 shares – a position worth £90,259
  • Operating cash flow is up 47%. (Even its operating margins are rising every year!)

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Should you invest the value of your investment may rise or fall and your Capital is at Risk. Before investing your individual circumstances should be considered, so you should consider taking independent financial advice.

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