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Should I buy Tesco shares today?

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The Americans are coming — to our stock market, that is!

And I don’t blame them. US investors must be fed up with the huge earnings multiples they need to pay to own some of their own popular stocks.

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But because the US stock market has been looking expensive, many US fund managers and investors are shouting about all the ‘cheap’ shares here.

Indeed, compared to what looks like an over-heated market in America, our stocks would look cheap, wouldn’t they?  

Are London-listed shares really cheap?

But are London-listed shares actually cheap? Some are. But some just look like bargains when compared to expensive stocks in fast-growing sectors. Or when compared to US stocks that appear to be over-bought in similar sectors in the US.

For example, one name getting frequent mentions is Britain’s supermarket giant Tesco (LSE: TSCO). And with the share price near 281p, the forward-looking price-to-earnings ratio is running near 11 for the trading year to February 2023. That’s when compared against City analysts’ expectations for earnings.

At first glance, that’s an undemanding valuation. But I’m not forgetting Tesco operates a low margin, high turnover business. What’s more, it’s been in retreat from its global expansion programme. And it’s spent many years fighting to retain market share in the UK against a sustained assault from low-cost, disrupting competition.

And it wasn’t that long ago Tesco owned up to running its business ‘hot’. In other words, it had been skimping on investment costs, running up selling prices, and squeezing the prices paid to suppliers. And it was all done in the name of wringing as many pounds in profit from the business as possible.

But although the accounts might have looked good in the short term, no business can prosper long term with policies like that. Instead, it’s best to reinvest in assets, build fair and sustainable partnerships with suppliers, and sell products and services at a price offering customers the best possible value.

Tesco turned around, but I still think it’s risky

And sure enough, Tesco’s bottom line crashed, customers disappeared in their droves, and the company plunged into a deep-rooted restructuring and turnaround programme. The acceleration of international retreat was just one outcome of that.

At the time, US investor Warren Buffett famously got himself caught up in the situation. And he ended up selling his Tesco shares at a loss when his faith in the management team disappeared. However, Tesco moved on and declared its turnaround complete some time ago and before the pandemic started. And it may yet provide a decent long-term investment for its shareholders. For example, the current share buyback programme may help the stock progress.

But, to me, it remains a low-quality business operating in one of the most competitive sectors in existence. The big numbers in the accounts for revenue and costs are huge compared to the small numbers for profits. And it wouldn’t take much of a shift in the big figures to turn the smaller profit figures from blue ink to red.

So, to compensate for the risks, I’d want a dividend yield of at least 5% before investing. But right now, the forward-looking yield is less than 4%. So, to me, Tesco isn’t a cheap stock and I’m not buying any of the shares today.

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Kevin Godbold 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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