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At 226p, is the Tesco share price a bargain?

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A shopping basket filled with Tesco own-brand goods
Image: Tesco

After consolidating its shares in February and paying a special dividend of 50.93p, the Tesco (LSE: TSCO) share price has stayed mainly flat ever since. This is despite the company announcing fairly strong full-year results. As such, do I think that the Tesco share price is too cheap or is there very limited upside potential?

Trading update

The trading update had many positive aspects, as well as some issues. From a positive perspective, revenues were fairly strong at £57.9bn. This was only a 0.4% drop from the previous year. Furthermore, excluding fuel sales, revenues were actually 7% higher than the previous year. A 7% rise is impressive and demonstrates how Tesco has performed well during the pandemic. This result also shows the negative impact of fuel sales on revenues, something that should be able to improve this year due to rising oil prices and more demand.  

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Notwithstanding the special dividend, Tesco’s dividend also came to 9.15p for the year. This equates to a yield of 4%, and I can see limited risk of it being cut any time soon. In comparison to the majority of other FTSE 100 stocks, this is strong.

Nonetheless, operating costs for the firm did increase, and this meant that operating profits were 28% lower than the previous year. This was also due to the poor performance of Tesco Bank, which saw a full-year loss of £175m. As such, the trading update was not all positive, and this means that the Tesco share price has not risen significantly since.

What does the future hold?

Fortunately for the supermarket, many of its Covid-linked costs are likely to be short term. This means that I can see a recovery of profits for the company over the next couple of years. Furthermore, Tesco was able to increase its market share for the first time in four years, showing promise for the future. As such, I believe that steady growth is on the cards.

Nonetheless, this recovery of profits is far from guaranteed. Indeed, there’s the risk that customers start spending significantly less at supermarkets in favour of going out to restaurants and pubs and shopping at other retailers now they’re open. If the number of customers favouring online shopping decreases after the pandemic, this may also benefit discount supermarkets such as Lidl and Aldi, that don’t have an online presence. As such, the increase in Tesco’s market share may be short-lived.

Is the Tesco share price too cheap?

With a price-to-earnings ratio of 19, the Tesco share price looks reasonably priced to me, rather than an absolute bargain. This means that I can’t see significant upside potential and I’m not going to add it to my portfolio.

Nonetheless, this doesn’t mean that I think Tesco is a bad stock. Indeed, its dividend of over 4% is very tempting, and compared to the other supermarkets, I would say that it has a competitive edge. I just feel that there are other stocks out there with higher growth potential. This is why I’m not buying Tesco now. 

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Stuart Blair has no position in any of the shares 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.

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