Does Tesco PLC’s (LON:TSCO) PE Ratio Warrant A Sell?
I am writing today to help inform people who are new to the stock market and want to learn about the link between company’s fundamentals and stock market performance.
Tesco PLC (LON:TSCO) is trading with a trailing P/E of 21.3, which is higher than the industry average of 18.2. Though this might seem to be a negative, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Check out our latest analysis for Tesco
Breaking down the Price-Earnings ratio
P/E is a popular ratio used for relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for TSCO
Price-Earnings Ratio = Price per share ÷ Earnings per share
TSCO Price-Earnings Ratio = £2.58 ÷ £0.121 = 21.3x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to TSCO, such as company lifetime and products sold. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. Since TSCO’s P/E of 21.3 is higher than its industry peers (18.2), it means that investors are paying more for each dollar of TSCO’s earnings. This multiple is a median of profitable companies of 11 Consumer Retailing companies in GB including Conviviality, Lenta and O’Key Group. You could think of it like this: the market is pricing TSCO as if it is a stronger company than the average of its industry group.
Assumptions to be aware of
However, you should be aware that this analysis makes certain assumptions. Firstly, that our peer group contains companies that are similar to TSCO. If this isn’t the case, the difference in P/E could be due to other factors. Take, for example, the scenario where Tesco PLC is growing profits more quickly than the average comparable company. In that case, the market may be correct to value it on a higher P/E ratio. We should also be aware that the stocks we are comparing to TSCO may not be fairly valued. Thus while we might conclude that it is richly valued relative to its peers, that could be explained by the peer group being undervalued.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current overvaluation could signal a potential selling opportunity to reduce your exposure to TSCO. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
Future Outlook: What are well-informed industry analysts predicting for TSCO’s future growth? Take a look at our free research report of analyst consensus for TSCO’s outlook.
Past Track Record: Has TSCO been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of TSCO’s historicals for more clarity.
Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
