Tesco (LSE: TSCO) shares have been in fine fettle in 2024, easily out-performing the FTSE 100 index. But why have they done so well? And what might 2025 hold for our biggest supermarket?
Great year
As I type, anyone investing at the start of the year would be up around 25%. That’s on par with the S&P 500 across the pond, replete with all its tech titans.
Much of this lovely return can be attributed to the company successfully taking the fight to upmarket rivals such as Waitrose via its Finest range of foods while also price-matching products with German budget operators Aldi and Lidl. A recent ruling by the competition regulator that loyalty schemes, including its Clubcard, provide genuine savings to customers also boosted sentiment.
But Tesco’s actually been doing well for a while now. Anyone buying in when UK inflation peaked at 11.1% in October 2022 (and the share price was languishing at 200p) would be looking at a stunning gain of 83%.
Can this carry on?
One reason why Tesco’s purple patch might continue into 2025 is incredibly simple. Regardless of the state of the economy, we all need to eat. With its 28.1% grocery market share, one could argue that the £25bn cap business remains a brilliant defensive bet. Closest rival Sainsbury‘s share is just 15.9%.
As things stand, analysts believe earnings per share will rise around 8%. That’s not exactly eye-watering growth. But I fancy quite a few UK businesses would settle for this.
Management’s decision to sell its banking operation to Barclays is another positive move, allowing management to focus its efforts on driving the retail business forward. As it happens, the aforementioned buyer recently raised its price target on Tesco to 415p –13% higher than where it currently stands.
Why might the shares come unstuck?
Tesco shares already change hands at a price-to-earnings (P/E) ratio of 14. That’s not all that different from the average among UK stocks. But it is a little expensive for a ‘consumer defensive’ stock with low operating margins and a fair dollop of debt on its books.
The forecast dividend yield also stands at 3.6%. This is very close to what I might expect from just holding a FTSE 100 tracker. So an investor won’t receive much more passive income, despite taking on the extra risk that comes with holding stock in a single company.
Those bi-annual payouts can’t be guaranteed either. Let’s not forget that Tesco cancelled dividends completely in 2015 after a nasty accounting scandal. Investors didn’t begin receiving cash again until November 2017!
There are other things worth noting. As a huge employer, Tesco will have to make higher National Insurance contributions from April following Chancellor Rachel Reeves’s first Budget back in October.
All this before we’ve contemplated what might happen if inflation bounces higher than expected.
Grocery king
I’d be surprised if this company manages to replicate its 2024 performance in 2025. But a more Foolish question to ask is whether investors should still consider buying as part of a diversified portfolio for the long term.
I can’t see much to suggest it’s about to lose its crown. So, I’d say the Tesco shares still warrant attention.
