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Here’s why the Tesco share price scares me, and why I’m steering clear

Image source: Getty Images.

You’ll surely have seen some version of ‘Past performance is not a guide to future results’ many times in the financial press.

But at the same time, aren’t we always being told we should get to understand our companies inside out and only go for those with great track records? How do we square that up?

One of the best examples of that dilemma these days, I think, is Tesco (LSE: TSCO)

From the depths of December 2015, Tesco shares have gained an impressive 80%, so is the supermarket giant getting back to its old money-spinning days one again?

I think that’s the wrong question to ask, and it’s based on the notion that there’s still the old Tesco out there just waiting to resume its pioneering ways. Going for companies with a great track record is a solid investment strategy, but the key to using it is to understand when a company has fundamentally changed and when it’s time to wipe the board clean and start again.

New start

I think that is definitely the case with Tesco. After all, while Tesco shares might have had a great recent run, they’re still worth little more than half their value at their 2007 peak. It’s been a disastrous decade.

Tesco is a very different company now, in a very different market, and I reckon potential investors should try to ignore everything they knew about Tesco and start again from scratch.

On the valuation front, analysts are forecasting earnings growth of close to 20% per year for the next two years. But even with that, the P/E would come down to only about 16 by February 2020. The dividend should be coming back, but is expected to still yield less than 3% by then. That’s not a valuation that has me reaching for the ‘Buy’ button, and I explained recently why I don’t think Tesco shares deserve to be valued above the FTSE 100 average.

Partnership

Tesco has just announced a strategic partnership with France’s Carrefour, aimed at pooling the two companies’ purchasing powers and helping get down the prices of own-brand goods. I’m not sure how our government’s near comical Brexit shenanigans might affect that, though I do see it as a good move.

But it does reinforce the big shift that’s taken place. It’s no longer about who has the best stuff or the best ideas, but about who has the lowest prices. It’s an almost completely commoditised market today, and price competition is just about all that matters.

And Tesco, rather than pioneering such moves as it might have been expected to a decade ago, is still playing catch up. Lidl and Aldi are the experts at selling cheap own-brand goods, and Amazon is increasingly encroaching on Tesco’s home turf.

Low growth?

The turnaround has been better than I had expected at this point, but fellow Motley Fool writer Kevin Godbold, who has described Tesco as a “falling star in a challenged industry,” doesn’t see a sustainable growth story in what is possibly our most competitive sector. I agree.

Whether you agree with my bearishness or not, I do reckon the key to evaluating Tesco now is to forget the past glory days, as they’re not coming back. Instead, it’s all about how today’s brand new Tesco will fare in a much-changed market.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon. 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.