I’ve seen a lot of investors bashing Tesco recently, so if we’re all Tesco bears now, then who’s going to be the next supermarket champion?
When I’m looking at a new investment, I look mostly for a quality company at a value price.
So let’s take quality first.
I’m a numbers guy with a background in computers, so I don’t measure quality by going into a store and checking to see if it’s dirty, the fruit is fresh, or the staff are smiling. I look at the numbers.
In terms of quality, one way of defining quality is that the company is able to grow various key results on a consistent basis. Growth isn’t synonymous with quality, but because of inflation, if a company isn’t growing over many years, then it’s actually shrinking in real terms.
My favourite key metrics are sales, earnings and dividends, and here they are for Sainsbury’s:
Hmmm, that looks like a company coming out of a hole to me, and indeed there were some big problems in the middle of the last decade. However, since the ‘hole’, Sainsbury’s has managed to grow revenues by something like 25% in 7 years, which still isn’t quite enough to set my pulse racing.
In terms of consistency, the company scores only 2 out of 10, which is based on the number of ‘new highs’ for sales, earnings and dividends. However, if I were only looking at the recovery period, then it would be 9 out of 10. So a big question mark over whether that recovery can become sustainable above inflation growth in the future.
Moving on to value…
If quality is hard to pin down, then value is next to impossible. However, it’s a task worth taking on, so I use a mixture of PE10, growth rate and yield.
For Sainsbury’s, the PE10 is around 14, growth is zilch (over the last decade), and the yield is about 5.5%. Those numbers are average, below average and above average, respectively. This means that out of the key value metrics of low price to earnings, good growth and good yield, Sainsbury’s only manages one above-average score.
And finally, is this an investment or just speculation?
For me, an investment is something that may take years to show fruit. Speculation is something that you hope will give you big returns in a short time – think lottery or the casino.
In order for an investment in a company’s shares to be an investment, it has to be reasonably certain that you will make a fair profit over a number of years, which means that the company has to at least exist in a few years time.
On that point, I think Sainsbury’s is fine. They do have quite a lot of debt, with interest payments covered less than ten times over by earnings, but they’re in a very steady business.
They are a large company in the dominant market group, and I guess most investors would expect the company to exist a decade from now.
The question, then, is more about whether good returns can be made. I think that with a 5.5% yield which is reasonably (but not fantastically) covered by earnings, and a company that is likely to grow around the rate of inflation, Sainsbury’s has a good chance of producing adequate returns for shareholders.
If an investor was after outstanding returns from Sainsbury’s, then I think they may need a good dose of luck to sprinkle on those shares.
Hi John
Interesting that you don’t like Sainsbury’s and I guess this demonstrates perfectly why when someone is selling somebody else is always wanting to buy in a liquid market. I bought a big chunk of Sainsbury’s back in December 2011 as part of a HYP strategy I have now started playing with.
I paid £2.8979 (today trading at £2.849) for a rearward looking div. yield of 5.2% at the time. It came down to SBRY vs TSCO in this sector with MRW eliminated because of the low yield. SBRY came through against TSCO as it’s yield was significantly higher, 5 year div growth is higher (55% vs 50%) and the ratio of operating cash flow to dividends were similar (3.2 vs 3.4). The dividend cover was however lower at 1.8 vs 2.5 however I’m leaning towards putting more weight on cash flow to divs than div cover with 1.8 still reasonable.
Cheers
RIT
Hi RIT, good to see you back on the scene again. It’s not that I don’t like Sainsbury, perhaps the post comes across more negative than I intended. The quality figure of 2/10 is purely quantitative and is too low I think; I’ll have to adjust it if I use it again and I’ve already worked out how.
What I meant was that for me it seems to be okay, but not much more. I certainly don’t think it’s in the same league as Tesco in the longer-term, although of course nobody knows for certain. The reality is that anything with a 5% plus dividend which is likely to grow in line with inflation is probably a reasonable investment, so I don’t think you’ve made a bad move.
Perhaps we can compare notes in 2017 and see how it all worked out?
Personally, I prefer Tesco, they’re quite good value, cheaper than Sainsbury’s on PE basis and hopefully will be a recovery play as they sort out their UK business, which I believe they will do eventually and that will create problems for their smaller UK competitors. After a few years, they may well dump their US business, which would probably lift the share price.
Tesco is a huge company, has interesting overseas prospects and their online offering appears far ahead of its UK rivals + if they ever do full service retail banking in the UK, that could be very interesting as well — the UK banking market is ripe for a new big name entrant with something better to offer & Tesco is very well placed. They also score higher on metrics such as return on equity — I noted with interest that Buffett topped up his holdings after the profit warning.
Hi Justin, must say I agree with that. Sainsbury’s is okay, while Tesco appears to be more than just okay. The Buffett/Tesco thing was quite a big thing at the time because of the opposite opinions of Buffett and Woodford, two ‘giants’ of the value world.
Sainsbury’s is interesting if you look at it from a pure value / asset perspective. When I last ran the numbers (which admittedly was a couple of years ago) they had property assets way over their market value. Of course they need them, and arguably with the likes of Tesco scaling back UK floorspace expansion as Amazon turns half the nation into postmen with hernias, you might argue this sort of commercial property has had its day. 😉
Hi M, I used to look at assets for value but I’m not too bothered now. I stick to earnings because if the assets aren’t generating earnings then I don’t really care if they exist. For Sainsbury’s, if they own lots of their stores then that helps keep rent costs down, but it should show up in margins and elsewhere.
They aren’t going to liquidate, so there’s no value in the property there, and like you say capital assets can be a liability in some ways.
Lots of activity on your blog though with MWAP Pete. I fear he may get a mild kicking over market timing…