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Why I Still Like Tesco Stock

British super-retailer Tesco (TSCO.L)(TSCDY.PK) remains one of my favorite stocks at current valuations. My preferred purchase price is below 400p. Let me explain why:

Currently EPS forecasts stand at 35.89p for the end of February 2012 and 39.67 for the following February. Using these figures on a rolling basis we calculate a figure of 37.14p for the next 12 months. Based on a share price of 400p, the price earnings ratio is 10.77

Over the last five years Tesco has produced the following multiples at year’s end:



Year End


2007


2008


2009


2010


2011


P/E


19.9


14.6


11.5


13.2


11.3




The above table provides a perfect snapshot of P/E performance as the table captures the bull market high of 2007 and the bear low of 2009. Of interest is the fact that the end 2011 multiple (remember that Tesco’s year end occurs in February) is lower than that of 2009.

The average multiple over the last five years is 14.1 which compares favorably to the current 10.77 figure.

Tesco’s EPS figures can be summarized likewise:



Year End


2007


2008


2009


2010


2011


EPS


22.36


27.37


29.06


31.80


35.90


% Growth


+10


+22


+6


+9


+13




The average EPS growth rate during the period was 12%. However, this is likely to slow somewhat in the future. EPS growth for 2012 and 2013 is forecast to be 10% per annum.

Simply put, under "normal" market conditions we can take the average P/E of 14 and multiply it by our rolling EPS figure of 37. This would easily give us a rough valuation of 518p per share. Should Tesco continue its share buybacks this figure could be higher.

A P/E of 10.77 is simply too low for a FTSE100 constituent like Tesco, especially since the company has the longest uninterrupted annual dividend increase, which spans 26 years, of the FTSE companies. Tesco is a therefore a fully fledged member of the S&P European 350 Dividend Aristocrat list.

The recent dividend history can be viewed in the article here:

The 2011 dividend came in at 14.46p and 2012 forecasts are for a 15.64p dividend which on a share price of 400p equals a 3.91% yield.

Historically the dividend yield has averaged 3.04% as shown in the following table:



Year End


2007


2008


2009


2010


2011


Yield ( % )


2.2


2.7


3.6


3.1


3.6




Therefore with a share price of less than 400p, I am buying the shares at a historically low multiple and a historically high dividend.

As for a little cream on the cake we can use the above figures to calculate return on retained earnings. For Tesco this figure comes in at 15.65% which, for the retail sector, is very good.

We can compare this figure to Walmart (WMT), which has a 9.19% return on retained earnings. Incidentally, Walmart trades at a multiple of 12.78 versus a five-year historical multiple of 15.86.

Obviously, investment decisions should incorporate a lot more information than contained in this article, but I am happy with management (especially the new CEO Philip Clark) and the direction of the company (perhaps with a little doubt over US operations).

Disclosure: Long Tesco Stock

About the author:

Liarspoker
Stockbroker @ www.market-swings.com

Visit Liarspoker's Website


Rating: 3.5/5 (19 votes)

Comments

graemew
Graemew - 3 years ago


Yes, Tesco definitely looks like the kind of company to buy and hold for the long term...with a good dividend, defensive products and good emerging market exposure.
Liarspoker
Liarspoker - 3 years ago


Thanks for your reply Graemew and also for reading the article.

Tesco is definitely a long term hold for me. Project future earnings forward for a couple of years and the shares are very cheap. The above article only looks at a target price over the next 12 months nevermind possible earnings growth over 5 years.

A quick calculation: Say on a multiple of 13 and 7% annual EPS growth from a base of 35.9p a target price of 655p. Alternatively a multiple of 14 ( 5 year historic average ) and 8% EPS growth from a similar base of 35.9p equals a target price of 705p.

Don't forget the dividend either. 5 years out at 8% compounded annually from 15.64p comes to 22.98p. Based on a purchase price of 400p this gives a yield of 5.75%. Compounded by 8% annually over a decade gives a yield of 8.44%. Tasty.

At the very least Tesco deserves a part in a diversified dividend portfolio.

A long term hold also allows us to make less decisions, save on commissions and other fee's, compound cash that would otherwise be spend on tax from pulling out profits etc etc.

We are nearing sub 400p btw. Todays closing price is 402.3p on the bid. I recently picked up a few shares at around 382p so I'll add if we see prices around that area though I might be tempted in sooner.
Liarspoker
Liarspoker - 3 years ago


Just to add that the current share price is the same as that back at the end of 2006 !!

Obviously we had a large rise in the share price since then, followed by a large fall which, subsequently, was followed by a large rise to bring us to where we are now.

Anyhow equity at the end of 2006 ( 2007 FY since year end is Feb - 2007 ) stood at GBP 10.57bn. In the last annual report ( Feb-2011 ) equity has risen to GBP 16.62bn.

As far as I could calculate from newspaper articles Warren Buffett stopped buying Tesco at the end of 2006 at just under 400p. So if the company was good value then, accoring to the Oracle, it must be better value now.

Food for thought.

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