Earlier this week, the tills were ringing furiously at Tesco (LSE: TSCO) stores up and down the country. Shoppers putting everything from turkeys to televisions in their shopping trolleys can be a useful reminder of just how big a business the nation’s leading grocer has.
One thing I did not have on my Christmas list, however, was Tesco shares. Nor do I plan to add them to my shopping basket any time soon.
Two different elements to successful investing
The reason why can be explained by considering the investing wisdom of billionaire Warren Buffett. It can also be illustrated by reference to the very idea of shopping at Tesco.
When looking at a product on a shelf, a customer may well have two thoughts going through their head (even if only subconsciously).
One is whether the product is good quality. Tesco’s Finest range of own label products emphasises the idea that some products are simply better quality than others. But the second question a shopper may have is about the product’s value.
One common mistake is confusing price with value. In fact, value is more complicated than price alone. Value is about the attractiveness of a certain product at a certain price. A good product can still offer poor value, at the wrong price.
As Buffett says: “Price is what you pay, value is what you get”.
That is true for shopping at Tesco, or any store. But is also true about investing. That explains why Buffett does not just aim to invest in great companies. He has two considerations in mind: investing in brilliant companies, but doing so only at an attractive share price.
Here’s my Tesco conundrum
That approach helps explain my take on owning Tesco shares. On one hand, I do think Tesco is a great business. Its strong position in the market gives it economies of scale. That strong position also reflects some of what the retailer does so well. It has a deep understanding of its customers thanks to its loyalty programme. That customer base is massive.
Tesco has a well-developed store format strategy allowing it to cater to different parts of the market, from small urban convenience stores to out-of-town hypermarkets.
But currently, Tesco shares sell for 20 times earnings. I do not see that as an attractive price.
Could Tesco offer value?
It is because of that valuation that I do not plan to invest. Tesco has a strong business in a market with resilient demand. But it is a competitive market with low profit margins.
A price-to-earnings ratio of 20 is often enough to put me off a growth company with high profit margins – and that is not how I see Tesco.
If the share price fell sufficiently, I could see Tesco reaching an attractive valuation. Alternatively, the current share price could make sense to me if I saw reasons to believe that future earnings per share are likely to be markedly higher than today.
Given its competitive marketplace though, that is not my expectation. So taking a leaf from Buffett’s book of investing, I have no plans to buy Tesco shares this festive season – or any time soon.
