To me, Tesco (LSE:TSCO) shares look a little expensive. The company has a lot going for it, but the valuation is starting to look a little stretched, especially after surging 16% over the past month.
Now, it should be said that the stock fell nearly 10% at the beginning of January after its results failed to impress. That means the 16% surge over the past 30 days had a reduced starting point.
Punching higher
Anyway, what has happened to push the stock higher?
Well, here are my presumptions.
Firstly we may have seen some dip-buying. This occurs when investors see a company’s share price fall, and they see it as an opportunity to buy.
Then, on 9 February, the shares broke above their 200-day moving average — a technical indicator that many traders watch as a signal that the long-term trend has turned positive, potentially triggering additional buying momentum.
Essentially, when the share price crosses this threshold, algorithmic trading systems and momentum investors often interpret it as a buy signal, triggering a wave of purchases that can push the price even higher — regardless of whether the company’s fundamentals have actually improved.
There also appears to have been some positive signs from the wider industry with Worldpanel indicating that shop price inflation is now at a nine-month low. While this could signal more competition, it may also highlight falling cost pressures and make customers more willing to spend.
We’ve also seen a bit of rotation out of technology companies, especially software. Investors may have sought shelter in reliable Tesco.
Price limits near-term appreciation
The result of this surge, however, is a stock that just looks a bit pricey compared to its peers and historical norms.
How much a stock should be worth is subjective. But the best investors are largely guided by data and metrics.
So, what does the data tell us now?
Well, Tesco is now trading at 15.6 times forecast earnings for the next 12 months. That’s considerably above peers like J Sainsbury at 14.1 times and Marks & Spencer at 12.5 times.
Of course, the price-to-earnings ratio isn’t the only indicator of value. And really it should be relative to net debt and earnings growth.
The problem for me is Tesco has a net debt position circa £10.3bn. Earnings growth for the year just finished was estimated around -4%. For the year coming, it’s expected to be around 10.5 times positive growth.
Collectively, I’d suggest the debt and growth story doesn’t complement the valuation. Marks & Spencer, for example, looks strong on both. While Marks has a less attractive dividend, it is my sector pick — and worth considering.
But back to Tesco. Great company with huge economies of scale, yet I see limited chance for share price growth in the near term given current prices. It’s still worth considering for patient investors though — the ability to leverage its size and brand strength should continue generating value over the long run.
Nonetheless, my take is there’s better value elsewhere in the sector.
