Tesco PLC, J Sainsbury PLC And WM Morrison Supermarkets PLC: Are The Supermarkets Value Traps?

We used to think of the supermarkets rather like we think of Apple: a remorseless trend of expansion, growing profits and a growing share price. The more smartphones Apple builds, the more they sell. The possibilities seem almost infinite.

No tree grows to the sky

But no tree grows to the sky; eventually the tree’s height is countered by the pull of gravity. Growth always has its limits. And so it has proved with the supermarkets.

The supermarkets are now starting to think less like Apple, and more like OPEC. They have realised that, while retail demand in the UK has remained largely static, supermarket supply has been increasingly linearly all the way since the 1950s.

It’s been a simple process. Each decade the supermarkets have built more shops, and they have increased their sales, and their profits. And their share prices trended higher and higher. This continued until about the time of the Credit Crunch, when something interesting happened.

Ever since the Great Recession the supermarkets have still been expanding, yet they have no longer been growing sales, and their profits have begun to fall. The share prices of these retail giants have begun to trend downwards.

A long road to recovery

This year the supermarkets’ results have been terrible. It’s as if they have hit a brick wall. People initially talked about Tesco having difficulties, but we can now see that Tesco (LSE: TSCO), Sainsbury (LSE: SBRY), Morrisons (LSE: MRW), Asda and even Waitrose have all been suffering. This thing is happening across the board.

Until now I have thought of the supermarkets as contrarian plays and turnaround prospects; my view was that their difficulties were just bumps in the road. But these results have made me think that there is something more fundamental at work here. Some investment experts have started to talk about the supermarkets as value traps. This sounds very harsh. But is there the possibility these experts may be right?

I am certainly holding off from investing in this sector, no matter how low share prices have already fallen. The balance between supply and demand has been lost. The supermarkets need to shift their focus from volume to profitability. In the past, increasing volume meant increasing profits. In the future, it will mean decreasing profits.

As the economy improves, retail receipts will start to rise. This gives the supermarkets hope, but the road to recovery will be long. I think it is still much too early to invest.

Investing in stocks and shares is not easy. At one point the supermarkets looked like a sure thing; yet now investors seem to be steering clear. How can we get a handle on what we really should invest in?

Well our experts at the Fool have written a guide about where we think the smart money is being invested.

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Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK owns shares of Tesco. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.