In January 2016, Tesco (LSE: TSCO) shares were around 140p. But there’s been a long grind higher since then to today’s price around 268p. And over the past year, Tesco is up a little from around 242p.
Yet the stock was higher still in January at just above 300p. Then, of course, the war happened in Ukraine. And Tesco dropped along with just about everything else.
But I reckon there’s a fair chance the supermarket chain could see its share price move well above 300p again. But only if the business keeps delivering incremental annual increases in earnings.
A rising trend in earnings
However, the immediate forecasts are a little discouraging. City analysts reckon earnings are set to ease back by just over 13% in the current trading year to February 2023. But they see a partial rebound the following year of almost 7%. But, as with all forecasts, there’s plenty of potential for them to be wrong.
Tesco’s trading and profits were skewed by the effects of the pandemic. But I’m encouraged to see that multi-year earnings are on a generally rising trend, if I strip out the worst pandemic years.
And that outcome speaks of the success Tesco has being having fending off market-share-grabbing competition such as Aldi and Lidl. It’s clear the threat has been significant because the issue features in Tesco’s financial reports.
In January, with the first-quarter trading update, chief executive Ken Murphy delivered good news. He said the trading environment had been “incredibly challenging” but the business had outperformed the market. And he thinks that happened because of the company’s “material and ongoing investment in Aldi Price Match, Low Everyday Prices and Clubcard Prices”. He reckons such initiatives are “removing the need for customers to shop elsewhere”.
Investing for income
The company isn’t just sitting back and letting the discounters take its business away without a fight. And my guess is Tesco will continue to exist in the UK for many years to come. However, I would not invest in the company’s shares for capital growth because earnings look unlikely to shoot the lights out anytime soon. And profit margins are thin in the industry.
Tesco is far from being a superior business when measured against other operators in different sectors. But it is something of a cash cow as long as it hangs onto its fragile earnings ability. So if I did invest it would be for dividend income.
However, the forward-looking yield is running at just over 4% for the trading year to February 2024. But I’d want a bigger return to compensate me for the risks of owning the shares. And I won’t invest for a yield less than 5%. But that condition is missing from the equation right now.
Therefore, for me, it’s back to waiting. And I’m avoiding Tesco shares for time being, even though they’re below 300p.
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Kevin Godbold has no position in any of the 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.