Over the last year, Tesco (LSE: TSCO) shares have been on fire, surging from 180p to 248p, a gain of 38%. In contrast, the FTSE 100 is only up by around 3% in that time. So, Tesco has outperformed the index by a huge margin.
Can Tesco shares continue to smash the wider index going forward? Let’s take a closer look at the stock.
Tesco’s FY2018 results, released in mid-April, indicated that the company is turning things around after a challenging few years. For the year ending 24 February, group sales increased by 2.3% while operating profit before exceptional items rose 28%.
As a result, City analysts have been upgrading their earnings forecasts for Tesco over the last few months, and this will have had a positive impact on the share price. Looking at the chart, the stock is clearly in a short-term upward trend at the moment. If this trend can go on, then the stock could continue to outperform the FTSE 100. As they say in investment circles, “the trend is your friend”.
However, Tesco’s share price gains could be limited by its valuation, which looks a little full right now, in my view. Analysts expect the group to generate earnings of 14.1p per share for FY2019. At today’s share price of 248p, that equates to a forward-looking P/E of 17.6. That doesn’t stand out to me as good value, if I’m honest, as the median forward P/E ratio of the FTSE 100 is currently 14.6. Tesco looks a little expensive on a relative basis.
An analysis of the stock’s dividend yield results in a similar conclusion. Analysts expect a dividend of 5.3p per share from Tesco this year, which equates to a prospective yield of only 2.1%. In contrast, the FTSE 100 has a median prospective yield of 3.5%. So, on these valuation metrics, Tesco looks overvalued on a relative basis right now, suggesting that the stock may not be able to continue outperforming the FTSE 100.
Lastly, it’s also worth considering the competitive supermarket landscape, as this could have implications for the company’s performance in the future. In my opinion, conditions for Tesco are likely to remain challenging going forward.
For starters, competition from the German low-price chains Aldi and Lidl is likely to remain high. According to data from Kantar, both these companies are continuing to grab market share. Then there’s also the proposed merger of Sainsbury’s and Asda to think about. If this goes ahead, the new combined entity will have serious buying power, meaning that it will be able to lower prices on many of its products. Lower prices at Sainsbury’s could lure shoppers away from Tesco.
So, weighing up these factors, I’m not convinced that Tesco shares can keep outperforming the FTSE 100 forever.
As a result, I won’t be buying Tesco shares for my portfolio. I think there are better opportunities in the FTSE 100 at present, including a few of the stocks listed in the free report below.
Edward Sheldon has no position in any shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.