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Why I’d prefer the Tesco share price over Marks & Spencer in 2020

There’s something completely baffling about the share price of retailer Marks & Spencer (LSE:MKS). It has seen a sharp fall over the past year, a continuation of a five-year-long history of falling share price. In fact, so dramatic is this story, that my colleague, Paul Summers, wrote about how much worse off investors would be if they had invested in the stock five years ago.  

Yet, M&S has a high price-to-earnings (P/E) ratio of 36.8 times, higher than the 15.2 times for Next, which is a much better performer. It’s even higher than the 24 times P/E for Primark-owner Associated British Foods.  

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Uninspiring updates 

I’ve argued in the past a high P/E doesn’t always mean that a stock is expensive. Instead, it can be seen as the value investors put on it. A case in point is the FTSE 100 pharmaceuticals giant AstraZeneca, whose share price has been defying gravity despite a P/E of 48 times.  

But I am at a loss to find a similar justification for M&S’s high P/E. Its latest trading update is disappointing, with a 0.7% fall in revenue in the last quarter. What’s even worse is that the quarter covers the festive season. Imagine what the results would have been like if it didn’t. Or rather, just look at last quarter’s numbers, which showed an even bigger 2.1% revenue fall.  

Questionable dividend situation 

It’s true that M&S’s dividend yield isn’t bad at 5.9%. But there are two points to note here. One, the further the share price falls, the better the yield appears. Two, while it has managed to stay profitable, its level of profits has dwindled quite a bit in the past two years. I’m not sure how long, if at all, it will be able to maintain its dividends in this scenario. 

Disrupted by the fast-paced increase in online retailing over the past decade, brick-and-mortar retailers are going through painful transformations. Until these transformations are complete and positive results show up in M&S’s financials, I’d refrain from investing.   

Festive cheer 

As far as retailers go, I’m more inclined towards the FTSE 100 grocer Tesco (LSE:TSCO) despite its far lower dividend yield of 2.6%. One big reason for this, of course, is that it’s much cheaper than M&S, with a P/E of 18.3 times. But also because it has reported a comparatively encouraging trading update for the Christmas quarter. Its UK and Ireland market sales grew by 0.2%. 

The downside  

However, I’d heed some investing caution in this case too. The group’s overall sales for the quarter fell 0.9% because of its poor performance in Central Europe and Asia. Admittedly, these markets are minuscule for Tesco compared to the UK and Ireland, but are still a big enough drag to negate the gains from them.   

However, with Tesco maintaining its profits for the last two years and its optimistic outlook, I’m keeping it on my investing radar.

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Manika Premsingh has no position in any of the shares mentioned. The Motley Fool UK has recommended Associated British Foods, AstraZeneca, 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.