Back in April, I said I was so confident about the outlook for the Tesco (LSE: TSCO) share price, I’d be happy to invest £5k in the enterprise.
As it turns out, I was right on the money. Since that article was published, shares in the retailer have added nearly 20%, excluding dividends. Over the past 12 months, the stock’s returned 18%, including dividends.
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And after this performance, I still think the stock has room to run higher as the group enters its next growth stage.
Tesco share price outlook
Since 2014, Tesco’s been in recovery mode. The group’s been trying to move on from its accounting scandal, shrink a bloated business, and fight off the discounters, Aldi and Lidl.
It was making significant headway on all of these points until the pandemic struck. The resulting chaos meant that the company had to drop everything and focus on the health crisis.
But now the pandemic’s starting to recede, Tesco can look to the future. That’s what the business is currently doing.
After having shrunk itself down by divesting operations and culling unnecessary product lines, the company is now more focused than it has been for years. This puts it in a great position to respond to outside challenges and focus on what consumers want.
It also means management can focus on rewarding investors. A series of dividend hikes now means the stock offers investors a dividend yield of 3.7%. The group is also looking to return cash to its shareholders in other ways.
Alongside its latest trading update, the company announced it would be spending £500m repurchasing shares. This is only half of the firm’s £1bn annual free cash flow, so further cash returns could be on the cards.
Undervalued equity
The £500m buyback suggests management believes the Tesco share price is undervalued. It also indicates the company believes buying back stock could yield better returns for investors than using this cash to try and grab market share.
I believe using the extra cash for this purpose is the right decision. Buying back shares means the number of shares in the market will decline, and each existing shareholder will have a more significant claim on the company’s underlying profits.
I’d rather the retailer takes this action than use the cash to try and expand. As we’ve seen in the past, spending to grow doesn’t always yield positive returns for investors. Tesco’s misadventure in the US eventually cost the company £1.2bn.
Still, the buyback doesn’t guarantee the stock will outperform the market. Rising costs could eat into the company’s profit margins, which will likely negatively impact investor sentiment. Tesco also needs to make sure it’s investing enough to fight off the discounters. If it doesn’t, it may lose market share.
Despite these risks, I think the outlook for the Tesco share price is only improving. That’s why I’d continue to buy the stock.
