Warren Buffett bought this FTSE 100 stock 20 years ago. Here’s why it’s still worth considering today
In 2006, Warren Buffett started buying shares in Tesco (LSE:TSCO). And the UKâs largest supermarket chain has a lot of classic Berkshire Hathaway characteristics.
Ultimately, an accounting scandal meant Buffett’s investment didnât work out so well and the stock was sold overa. decade ago. But the key features that made it attractive in the first place are very much still intact.
Scale
In a 1976 letter to the then-CEO of National Indemnity, Buffett said the following:Â âI have always been attracted to the low cost operator in any business and, when you can find a combination of (i) an extremely large business, (ii) a more or less homogeneous product, and (iii) a very large gap in operating costs between the low cost operator and all the other companies in the industry, you have a really attractive investment situation.â
Despite some big issues during the previous decade, I think Tesco today meets all three conditions. With almost 29% market share in an extremely durable industry, itâs significantly bigger than Sainsburyâs, which accounts for around 16%.Â
Supermarkets are also pretty much homogeneous, with not much to differentiate one from another apart from prices. So thatâs the second condition taken care of.
In recent years, Tesco has achieved operating margins above 4%, while Sainsbury’s has been closer to 3%. That doesn’t sound like much, but it amounts to a lot more operating income.
Overall, Tesco looks like exactly the kind of business that fits Buffett’s description. So maybe that explains why Berkshire started buying shares in the company in 2006.
Strength
Having lower costs means being able to sell things for less than competitors and make more money. And in what Buffett calls a more or less homogeneous industry, thatâs huge.
In general, one way of doing this is being bigger than the competition. With Tesco, that creates better negotiating power with suppliers who want to reach customers in its 4,800 or so stores.
Thatâs what sets Tesco apart from other supermarkets and as long as it stays ahead, itâll retain the benefits of that scale. Itâs a really nice self-reinforcing competitive advantage.
The risk comes from the fact that there’s nothing stopping consumers changing from one to another. So Tesco is in constant danger of losing customers to rivals at short notice.
Thatâs something for investors to keep an eye on and it limits the companyâs ability to grow by increasing prices. But I think thereâs something even more important to pay attention to.
In a market where switching costs are low, the most important thing is Tescoâs ability to win customers from its rivals with its long-term advantages. And thatâs what I think matters most.
20 years later
Warren Buffettâs investment in Tesco ultimately wasn’t a good one. But the FTSE 100 company is now under different management and the accounting issues are well in the past.
Whatâs still the same though, is the firmâs status as the company with the lowest costs in a relatively undifferentiated industry. And thatâs what makes it worth considering today.
Buffett might not be interested in the stock right now, but I think UK investors should have it on their radars. Sometimes great opportunities are hiding in plain sight.
The post Warren Buffett bought this FTSE 100 stock 20 years ago. Here’s why it’s still worth considering today appeared first on The Motley Fool UK.
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Stephen Wright has positions in Berkshire Hathaway. The Motley Fool UK has recommended J Sainsbury Plc and Tesco Plc. 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.
