Supermarket chain J Sainsbury (LSE: SRBY) delivered a solid first-quarter trading statement back in July. But at 291p, the share price has reversed the spike of August that saw it knocking on the door of 350p or so.
One factor behind the volatility is the takeover speculation that gripped the sector in the summer. But there’s no doubt Sainsbury has been trading well. So, is the stock now a bargain?
Building back earnings
To put recent moves into perspective, even now the share price is around 65% higher than it was a year ago. So, at first glance, a lot of operational progress is probably already baked into the price.
Looking ahead, City analysts expect earnings in the current trading year to March 2022 to increase by around 13%. And the following year they expect an advance of about 5%. But even then, Sainsbury is merely rebuilding its earnings after what looks like a Covid crash in 2020.
The pace of earnings growth is pedestrian. And even in 2022, earnings will fall short of their peak in 2019. And I’m not surprised the business is struggling to make progress because the sector is characterised by cutthroat competition and low margins. But, in fairness, some factors will be working to support trading. For example, the demise of high street clothing stores means Sainsbury is one of the few destinations that people can still buy clothing without shopping online.
But the positives still don’t justify a high rating for Sainsbury, in my opinion. Neither does the possibility of a bid from another company that wants to take the business over. If something like that happens, it happens. But meanwhile, Sainsbury needs to trade at a valuation that makes sense of holding the stock.
A precarious and vulnerable business?
I used to think of supermarkets as fairly safe defensive dividend payers. But that was until the sector suffered its profit wobbles a few years ago. Now I see supermarket businesses as precarious and vulnerable.
However, I could be wrong. Share prices can go up as well as down. And my assessment of Sainsbury’s prospects could prove to be off-key. It’s possible the stock could end up being a decent compounding investment over the next 10 years or so.
But If I was going to hold the stock I’d want compensation for the risk I’d be taking in the form of a generous shareholder dividend. Yet the forward-looking yield is only about 4%. And that’s far too low for me. I want 5% at the very least and even more than that to feel confident about holding the shares.
And that means, for me, the Sainsbury share price does not make the stock an unmissable bargain.
Instead, I’m looking for solid, dividend-paying investments in sectors capable of producing steady, cash-producing businesses. So, I’m fond of searching in sectors such as utilities, energy, fast-moving consumer goods, IT and others.
And here's a great place to start my research:
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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.