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Tesco plc And WM Morrison Supermarkets PLC Face An Existential Crisis

What is the purpose of a company?

It’s an interesting question. And not one which is easy to answer.

What is the purpose of a company?

Some would say that it is to make money. Some would say that it is to create jobs. Some would say, to benefit shareholders. And others would say that it is for the benefit of society.

It is a question which is currently vexing both Tesco (LSE: TSCO) and Morrisons (LSE: MRW). Do these companies make money? Well, they certainly have a huge turnover. But, under pressure from premium brands Marks & Spencer and Waitrose, and budget stores Aldi and Lidl, both companies have made a loss this year.

Do they create jobs? Well, of course – in spades. Tesco is Britain’s biggest employer, with a total of 500,000 workers, almost all of whom are based in the UK. Morrisons employs another 125,000.

What about the benefit to shareholders? Well, there hasn’t been much recently. Tesco’s share price rose steadily in the nineties and naughties to reach 479p in 2007. Since then it has been on a remorseless downtrend, currently standing at 181p. And shareholders, of which there are many, have been steadily losing money.

What’s more, it seems unlikely that there will be any sustained rise in these firms’ share prices. Analysts estimate that the 2016 P/E ratio for Tesco is a worryingly high 42.27, falling to 19.43 in 2017. The dividend yield is 0.66%, rising to 1.51%.

Morrisons’ numbers are a little better, with a 2016 P/E ratio of 15.98, and a 2017 P/E ratio of 15.16. The dividend yield is 3.32%, falling to 3.19%.

But what about the benefit to society? Well, this is undoubted. Each of these retail giants has millions of customers. They sell a broad variety of products to serve every need. And the jobs they provide maintain whole communities across the length and breadth of Britain.

Customers vs employees vs shareholders

This illustrates the dilemma that these businesses are grappling with. What takes priority? Should you cut jobs to the bone to ensure that the company maintains its profitability and its share price? Or should you maintain employment levels, and accept the fact that the share price is destined to a slow decline?

What I sense is that these firms are taking a balanced approach. They know that there are too many supermarkets, and that this is the reason why they are not profitable. But they are closing only a few unprofitable stores.

Morrisons has sold many of its in-town mini-marts, while Tesco is selling much of its Asian business. This allows them to conserve resources so they stand a better chance of beating the competition in the UK.

Look at these companies with a sense of perspective, and you see that customers are happy, and employees are happy.

I feel that the share prices of both firms are set to fall further, as profitability is unlikely to rise. I would not currently invest in either Tesco or Morrisons.

But, if you think about it, maybe that doesn’t matter any more.

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