Tesco (LSE: TSCO) posted an encouraging trading statement yesterday. For the 19-week period to 9 January, group retail sales were up 7.8%. Meanwhile, the company delivered a record Christmas period, with UK and ROI sales up 8.7%.
Am I going to buy Tesco shares though? The answer is no. I think there are better stocks to buy. Here are five reasons why I’m avoiding TSCO.
Tesco shares: low growth prospects
Firstly, Tesco operates in a low-growth industry. According to Global Data, the UK supermarket industry is expected to grow just 15% between 2019 and 2024. That equates to annualised growth of just 2.8%. That’s quite low. By contrast, the cloud computing industry is expected to grow by around 18% a year between now and 2024.
Given this low industry growth, I can’t envisage Tesco getting much bigger over the next five or 10 years. And that’s not what I want from an investment. I want companies that are pretty much guaranteed to be much bigger in the future as that increases the chances of investing success.
As Warren Buffett said: “Your goal as an investor should simply be to purchase, at a rational price, a part interest in an easily-understandable business whose earnings are virtually certain to be materially higher five, ten and twenty years from now.”
The shift to online shopping
Secondly, the supermarket industry is undergoing a massive shift right now. What we’re seeing is a rapid transition to online shopping.
Tesco is experiencing good results in the e-commerce space. Yesterday, it reported 80% growth in this area. However, I don’t see it as the leader in digital shopping. In my opinion, that award goes to Ocado – which is a pure online grocery retailer. In its most recent trading update, for the 13 weeks to 29 November, it reported revenue growth of an excellent 35%. I’d be more inclined to buy Ocado shares than Tesco shares.
No competitive advantage
Tesco also has little in the way of a competitive advantage. This means there’s nothing to stop rivals stealing market share. And this is exactly what Ocado, Lidl, and Aldi are doing. Tesco’s market share has been declining for years now.
Going back to Warren Buffett, a competitive advantage is one of the first things he looks for in a company. He likes businesses that can protect their profits.
Another concerning issue is that Tesco isn’t a very profitable company. Over the last three years, its return on capital employed (ROCE) – a key measure of profitability – has averaged just 6.7%. That’s not great. Companies with this kind of ROCE generally struggle to expand because they don’t have a lot of capital to reinvest for growth.
Tesco shares aren’t cheap
Finally, the valuation on Tesco shares doesn’t appeal to me. Looking at analysts’ earnings forecasts for next year and the current share price, the forward-looking P/E ratio is 13.4. That’s probably about right for a low-growth supermarket. In other words, the shares aren’t cheap.
Overall, Tesco strikes me as a low-quality company. It operates in a low-growth industry, lacks a competitive advantage, and isn’t very profitable. All things considered, I think there are much better stocks to buy.
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.