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Tesco’s share price has fallen. Should I buy the stock now?

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Tesco (LSE: TSCO) shares have produced disappointing returns recently. Since late January, its share price has fallen from near 250p to 226p. Meanwhile, over the last 12 months, TSCO is down almost 10%.

Has this share price weakness created a buying opportunity for me? Let’s take a look at the investment case.

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Has Tesco’s share price fall created a buying opportunity?

When analysing a stock, one of the first things I look at is the company’s long-term growth potential. Growth is important because it’s the main driver of the company’s share price over the long run. Growth can also impact a company’s ability to consistently pay dividends.

Looking at Tesco, I’m not convinced there’s a lot of long-term growth potential. According to Global Data, the UK supermarket industry is expected to grow just 15% in total between 2019 and 2024. That equates to 2.8% annually. Meanwhile, City analysts expect Tesco to generate revenue growth of just 1.2% in the year to 29 February 2022.

It’s also worth pointing out that the supermarket industry is highly competitive. Not only is Tesco facing competition from the likes of Aldi, Lidl, and Ocado (which just had a great quarter) but now there’s Amazon to contend with. The online shopping giant has been capturing market share in recent years. And, according to The Sunday Times, it will be launching over 10 Amazon Go convenience stores across the UK in the near future, with a potential further 20 to follow.

Does Tesco have an edge over the competition that can help it protect its market share? Looking at market share trends in recent years, I’m not sure it does.

Financials

Turning to the financials, there are some positives and negatives. Tesco’s profits are anticipated to rise next year. Earnings per share (EPS) are predicted to rise to 23.1p from 13.8p. That’s encouraging.

However, Tesco’s return on capital employed (ROCE) – a key measure of profitability – has been quite low in recent years. Over the last three years, it’s averaged just 6.7%. I like companies that are more profitable than this.

On the dividend front, a prospective yield of about 4% does look relatively attractive in today’s low-interest environment. That said, Tesco doesn’t have a long-term dividend growth track record as it cancelled its dividend a few years ago. I like to invest in companies that have consistently increased their dividends (Unilever and Diageo are some good examples).

Overall, I’m not blown away by Tesco’s financials.

Valuation

Zooming in on the valuation, I do think Tesco shares sport a reasonable valuation at present. If it can deliver on the 23.1p per share earnings forecast (that’s just an estimate, remember), the stock’s forward-looking P/E ratio is just 9.8. That’s quite low. By contrast, the FTSE 100’s median forward-looking P/E is 17.2. So, as a value play, Tesco shares could offer some appeal.

Tesco shares: my view 

Weighing everything up, I don’t see enough appeal in Tesco shares to invest right now. The stock looks relatively cheap. However, I think there are other stocks I could buy – with more long-term growth potential. Ones that are better fit for my portfolio.

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Edward Sheldon owns shares in Amazon, Unilever, and Diageo. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended Diageo, Tesco, and Unilever and recommends the following options: long January 2022 $1920 calls on Amazon and short January 2022 $1940 calls on Amazon. 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.

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