Buying stocks at a fair price tends to pay off over the long term, but we all love to bag a real bargain. Bagging a bargain often requires patience.
Today, Im going to tell you the price I believe would put Tesco (LSE: TSCO) in the bargain basement.
Tesco has been on my watch list as a potential bargain ever since its shock profit warning, following poor Christmas trading in 2011.
The companys shares dropped from over 400p to nearer 300p, but I wasnt ready to leap in. For one thing, the profit warning was symptomatic of deeper structural problems, and, for another, history tells us that once a supermarket goes off course it takes an awful long time to turn around.
Despite the profit warning, Tesco had the support of legendary US investor Warren Buffett, as well as many loyal shareholders who saw the poor Christmas trading as a mere blip, and the fall in the shares as an opportunity to top up. As such, Tesco remained above my bargain-buy valuation: a forward P/E of no more than nine.
Earnings and dividend uncertainty
Tescos shares subsequently further declined, but with earnings projections also falling the P/E failed to get down to my bargain-buy level. After further profit warnings this year, the shares are currently trading at 183p.
I was beginning to think that with the passage of almost three years from the original profit warning it might be time to raise my bargain-buy P/E level a little. However, Tescos recent interim results, in which the company stated we are not providing full year profit guidance, have created a new level of uncertainty for earnings-based valuations.
Dividend yield as an alternative value marker has also been thrown into uncertainty, because, while Tesco has cut its interim dividend by 75%, management has given no indications of its intentions for the final dividend.
Im going to value Tesco based on its assets. Net asset value (NAV) at the most recent balance sheet date was 13.5bn, or 166p a share.
On a slightly more sophisticated calculation, I get a similar NAV (13bn) and price (160p). The difference between the market value of Tescos property and its value on the balance sheet (13bn) pretty much nets off against goodwill of 4bn + off-balance sheet liabilities of about 9.5bn (calculated on the usual eight times annual non-cancellable operating leases).
Id see Tesco as a real bargain if I could buy its net tangible assets at par. Therefore, I reckon Tesco would be in the bargain basement at a share price of below 160p.
Now, perhaps I’m being a little greedy with Tesco, but deciding on a price you are willing to pay for a company, and having the patience to wait for it, can enable investors like us to target a million-pound portfolio.
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G A Chester has no position in any shares mentioned. The Motley Fool owns shares in Tesco.