Understanding Amazon shares
Choosing between the two isn’t easy. I think Amazon has much brighter growth prospects. Indeed, the company is only expanding around the world, while Tesco is retreating. The latter sold its biggest overseas business last year and returned the cash to investors. Meanwhile, Amazon is still investing tens of billions of dollars every year growing its divisions across the globe.
And Amazon is far more than just a retailer. The company is probably best known for its retail business, but it also has a large advertising and cloud computing arm. Both of these divisions now provide the bulk of the group’s profit.
Tesco too has other businesses aside from its core retail division. It’s been investing more in its financial arm and mobile phone operation, although these are still small fry compared to the retail operation.
In my opinion, the debate of which is the better buy, Tesco shares or Amazon shares, comes down to simplicity and cash returns.
Tesco shares and dividend growth
I think Tesco is a very simple business. The company buys products from suppliers, adds a small margin, and then sells these on to consumers. There’s a bit more to it than that, but that’s the gist of it.
Amazon not only buys and sells from suppliers and consumers, but it also owns one of the world’s largest airlines, haulage businesses, cloud computing businesses and advertising businesses. Put simply, there’s far more to understand with the American company, and that’s why I’d buy Tesco shares over Amazon shares.
I’m a big believer in investing in what I only understand. I can understand Tesco’s business model. I roughly know how Amazon works, but I struggle to understand how the company’s retail division actually makes money.
Another attractive quality of owning Tesco over Amazon is the UK retailer’s cash generation. Management is targeting an annual free cash flow of £1.2bn. This should be enough to support the company’s 4% dividend yield, and then some.
Granted, this cash flow is minuscule compared to Amazon’s $31bn of free cash flow for 2020, but all of this is being reinvested back into growth. At least Tesco’s investors are getting some cold, hard cash in their pockets.
That said, Tesco’s growth is unlikely to be anywhere near that of Amazon’s going forward. That’s the trade-off. Tesco is an income stock. Amazon is a growth investment.
Risks and challenges
The risks facing each company are different as well. Competition in the e-commerce sector is fierce. This could hurt Amazon’s growth and profit margins. The same can be said for the cloud computing and marketing industries.
The UK supermarket sector is also viciously competitive. More competition and higher costs could hurt Tesco’s profit margins, leading to reduced free cash flow.
Even after considering these risks and challenges, I’d buy Tesco shares as an income investment over Amazon shares. However, I also think there’s a place for the latter in a growth portfolio.
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Rupert Hargreaves owns no share mentioned. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended Tesco and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. 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.