Why Warren Buffett Bought Tesco PLC

Imagine you were Warren Buffett. What was the reasoning behind his investment in Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US)? More specifically, why has he invested in Tesco rather than Walmart (NYSE: WMT.US)? Well, this is what he might have been thinking…

In simple terms, he likes to invest in long-term trends. One long-term trend is that people are buying more and more from supermarkets and less from corner shops, the high street and department stores. Why trek over to the high street when all the essentials can be bought during your weekly trip to the supermarket?

So the logical conclusion would be to invest in a supermarket. If you are an American investor like Buffett, then the logical choice would be Walmart, which is the dominant — and most profitable — player in the States.

Buying power and agility

But Walmart is already huge ($238bn market cap). How much bigger can it grow, particularly in the States? When a company reaches this size and scale, it is difficult to grow fast. And it is not particularly cheap (P/E ratio of 14, dividend yield of 2.5%).

Compare this with Tesco. This is a smaller company (a mere fifth of the market cap of its US competitor) with more of its sales overseas. The company is big enough to have massive buying power, but it is small enough to still grow rapidly, and to be agile in what can be fast-moving markets.

Plus its presence in many emerging markets is still nascent, so there is still the scope for much more growth. This doesn’t mean that there aren’t bumps along the way. Tesco’s foray to Walmart’s home ground of the States was a clear failure. But I think the company has drawn a simple but key lesson.

The partnership approach

It is not easy to go it alone in markets where there are already entrenched competitors. This, I think, is why Tesco is now seeking out partners and established brands in many of its ventures.

It is expanding into the restaurant business in the UK. But rather than create a brand from scratch, it has bought up the established and successful Giraffe restaurant chain.

To expand in China, rather than plough a lonely furrow it has joined forces with CRE, already a big player in China’s retail business. The concept is simple: rather than trying to build a brand from scratch, which is difficult and rather hit and miss, invest in an already established and successful brand.

Then, just by scaling up these brands, the company builds growth.

Yet, despite Tesco’s greater growth potential, it is actually cheaper than Walmart (P/E ratio of 10, dividend yield of 3.9%). Is this reason enough for Buffett to venture across the Atlantic to buy Tesco? I think so.

What’s more, this comparison of the rival supermarket titans gives us some perspective about whether Tesco is a buy or not. Although the company is not as cheap as when the share price slumped last year, the company is, in my view, a strong buy.

Good long-term investments

Tesco is the type of share that we at the Fool think is a good long-term investment. It’s the sort of company that we expect to grow and steadily increase profits — and thus its share price and dividends — for many years into the future.

We have such confidence in this company that we have made it one of our “5 Shares To Retire On”. Want to learn what other companies we would recommend as long-term investments? Then just click on this link to receive our report, which is provided without obligation and completely free.

> Both Prabhat and The Motley Fool own shares in Tesco.