It’s always tempting to go for a share with a name that’s familiar to most people, such as Tesco (LSE: TSCO), which has a big market capitalisation close to £21bn and resides in the FTSE 100 index.
However, Tesco operates in a difficult sector and faces big competition from many angles. There’s precious little to differentiate the firm’s offering from that of others, such as J Sainsbury, Asda, Lidl, Aldi, WM Morrison and others. At the local level, customers often have many choices about where to shop and could turn their backs on Tesco at any time if they become unhappy with the service.
Past its use-by date?
I think such market dynamics look set to keep Tesco’s profit margins in check and its growth options limited. Right now, the firm is rebuilding profits after a dreadful period of trading, but I reckon there’s a limit to how far the firm can go in terms of a turnaround. To me, the time for investing in Tesco for its turnaround potential has passed and I see the company as unattractive as a dividend investment or as an ongoing growth story because of the commodity-style nature of its business model.
Instead, I’d rather invest in a fast-growing company such as AB Dynamics (LSE: ABDP), the designer, manufacturer and supplier of advanced testing systems and measurement products to the global automotive industry. Today’s blistering full-year results couldn’t be more different from anything Tesco is likely to report at this stage in the supermarket chain’s life. Indeed, Revenue rose 51% compared to the year before, cash flow from operations shot the lights out by moving more than 370% higher, and diluted earnings per share elevated a healthy-looking 70%. The company’s progress reflects in cold, hard cash too, with the net cash figure increasing 66% to almost £16m.
The company’s founder and non-executive chairman, Tony Best, explained in the report that even though the firm is reporting “very strong growth,” the rate of incoming orders is running “ahead of sales.” This happy situation has led to a “healthy order book,” which provides good visibility for the new trading year. I reckon the firm’s growth looks set to continue. City analysts following the firm think so. They’ve pencilled in an increase of 21% for earnings for the current year to August 2019.
Best said that the company plans to support its growth in the coming year by investing in new product development, marketing, and the service and support function. The firm is also investing to grow its “overseas footprint” and opened a facility in Germany during the period. Such investment will provide some constraint to the operating margin, we’re told, but the outlook is positive and the company is “well positioned to deliver a year of solid progress.”
Meanwhile, there’s a new man at the helm. The chief executive, Dr James Routh, started on 1 October and change like that could usher in a new burst of energy to keep the growth story boiling. I think the stock is attractive and the firm’s strong trading niche looks set to drive the growth story further.
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended AB Dynamics and 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.