With the UK in a recession, many investors have moved into defensive shares. Those are investments in companies that are perceived to benefit from resilient demand, even when money is tight for people.
Classic examples include tobacco makers and supermarkets. But if I had invested in Tesco (LSE: TSCO) shares a year ago, I would be nursing a loss. In fact, Tesco shares are down a fifth over the past year.
A juicy yield north of 5% would have helped cushion the blow – but my investment in the supermarket giant would still be firmly in the red.
Tesco advertises its low prices as a bargain for shoppers. Could the current Tesco share price be a bargain for me as an investor?
Business outlook and share valuation
To answer that question for Tesco – or indeed any other share – I consider a couple of points. First, does the business have outstandingly good long-term financial prospects? Secondly, is it trading at an attractive valuation?
Strong business prospects
I think the answer to the first question is yes. No matter what happens, people need the basics of life including food. That will support demand for grocery retailers across the long term.
As the largest supermarket chain in the country by a considerable margin. With a large customer base and well-known brand, Tesco enjoys what I see as a sustainable competitive advantage.
The economics of the industry do concern me. Grocery retailing has high sales volumes but low profit margins. Online competition threatens to eat into margins further.
As market leader though, I think Tesco can optimise a digital sales model that helps it stay healthily profitable. As its online operations are far ahead of rivals Aldi and Lidl, I actually think the shift to online shopping might help not hinder Tesco in defending its market position.
Are Tesco shares attractively valued?
The Tesco dividend already attracts me. Not only is it juicy, but I see the prospect for further growth. It grew 19% last year and this year’s interim dividend was 20% larger than before.
But what about the share price? Currently, Tesco shares sell on a price-to-earnings ratio just below 10. That looks cheap to me for a business of its quality with the long-term commercial prospects of the grocery retail market leader. Both Asda and Morrisons have been bought in recent years, suggesting some institutional investors see value in the UK supermarket sector.
I feel the same. If I had spare money to invest today I would buy Tesco shares for my portfolio. As a long-term investor, the share price fall over the past year does not bother me, as I believe in the prospects for the business.
In fact, it just means that I can get a quarter more Tesco shares today for the same money as I could have done a year ago. As an investor, every little helps!
