UK Edition
The best time to buy shares is when the economy is experiencing temporary difficulties. This prompts weak market sentiment that allows investors to purchase high-quality companies at bargain prices.
With inflation of 6.8pc, economic growth of 0.4pc and interest rates that have risen on 14 consecutive occasions, Britain’s downbeat economic landscape provides a wealth of such opportunities.
Since no downturn has ever proved permanent, buyers of shares during today’s era of economic woe can reasonably expect to earn a good return in the long run. Indeed, market sentiment and corporate profitability are very likely to improve drastically as inflation falls, interest rate rises abate and economic growth improves.
In Questor’s view, Tesco is a prime example of a worthwhile buying opportunity during this period of temporary economic challenges. The company has relatively solid finances with which to cope with tough operating conditions, enjoys a hugely dominant market position over its rivals and currently trades at an attractive price that suggests capital growth is ahead.
In terms of financial strength, the company’s net-debt-to-equity ratio of 86pc is highly sustainable. Given that the supermarket sector has seen two debt-fuelled takeovers in recent years, namely of Asda and Morrisons, and that interest rates have risen to a 15-year high over the past two years, Tesco now has a clear competitive advantage when it comes to its financial position.
Its relatively modest debt levels mean it is not only better placed to overcome short-term industry weakness but is also able to improve its market position by withstanding narrower profit margins for longer than its rivals.
The company is already the dominant force in groceries. Although its market share declined by 0.2 percentage points to 27.1pc in the first quarter of the current financial year, it rose over the previous three years.
Moreover, its share of Britain’s online grocery market increased by 0.75 percentage points to 37.5pc in the first quarter of this year.
While online grocery sales as a proportion of the total have fallen from 15pc to 10pc since lockdowns ended, ecommerce sales are likely to resume their upward long-term trend in the coming years.
They still account for 50pc more grocery sales than they did before the pandemic. Since Tesco is better placed to capitalise on growing digital demand than most of its rivals, it is likely to be a major beneficiary of any further shift towards online sales.
With a price-to-earnings ratio of around 12, the company’s shares offer good value for money. Certainly, there are cheaper retail stocks available. But when the company’s market position is taken into account, its risk/reward trade-off looks favourable. When combined with a dividend yield of 4.3pc from a payout that is covered twice by profits, its total return prospects are highly appealing.
In terms of catalysts for getting the share price moving, an improving economic outlook is likely to boost investor sentiment towards the retailer. The Bank of England expects inflation to be below 3pc within 12 months.
This suggests that further interest rate rises may be more limited than many investors currently expect. And with the IMF forecasting that economic growth will rise from 0.4pc this year to 1pc next, the outlook for the economy, and domestically focused stocks such as Tesco, is likely to improve significantly.
Already, consumers appear to be looking ahead to the “green shoots” of recovery.
Consumer confidence, which stood at a record low just a year ago, has dramatically improved over the past six months.
Shoppers who are less price conscious may provide scope for higher profit margins across the sector. And while British shares are deeply unpopular among international investors at present, history suggests this trend is very unlikely to persist as an improving economic performance causes viewpoints to change.
Tesco’s shares have risen by 8pc and outperformed the FTSE 100 by nine percentage points since Questor first advised readers to buy them in October 2017. With the company’s operating outlook poised to improve markedly as temporary economic difficulties abate, and its low valuation alongside a clear competitive advantage, there is scope for significantly greater capital growth and outperformance of the index over the coming years.
Questor says: buy
Ticker: TSCO
Share price at close: 256.3p
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