Why I'd sell Tesco plc and buy Prudential plc
In a world turned upside down, how should investors react? Well, the world hasn't ended so investors, like the rest of us, will just have to keep on going.
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What the panic after the Brexit vote has done is open up many share price opportunities. Stock valuations have been falling across the board. But you have to be careful what you buy and what you sell.
In this article I'll present two companies whose share prices have taken a tumble. One is a company I think you should sell, and the other a firm I think you should buy.
Tesco
The supermarket sector in this country has been transformed in recent years. Once retail leaders such as Tesco(LSE:TSCO) and Sainsbury dominated the market, and made multibillion pound profits year-on-year.
But trees don't grow to the sky. At some point the growth will stop. Tesco has reached that point, as the number of grocery outlets in the UK has reached saturation point. There are simply too many shops in this country, and the growth of competitors such as Aldi and Lidl has added to the over-capacity.
In this situation, the only way to maintain revenues is to cut prices, and this reduces profits. That's why this once hugely profitable business is now only just breaking even.
A company's share price is determined by its current and future earnings. That's why Tesco's market capitalisation has been on the slide. In the boom years, the stock reached 473p. It's now at a third of that level. But even at 162p, this company is still expensive. The current P/E ratio is 27.73, with no dividend being paid out. The only reason you would buy into this business is if there's a strong likelihood of a turnaround. But that looks unlikely at this point.
Prudential
In contrast, insurance giant Prudential(LSE:PRU) is a firm that has been growing profits steadily since the Credit Crunch. As well as operating in markets such as the UK and the US, it has a large stake in emerging markets across Asia and Africa where the financial services industry is starting to boom.
The success of this firm has led to a rocketing share price, but a recent pullback has caught the attention of contrarians. What's more, the current market turmoil has pulled the share price even lower. Yet earnings progression remains robust. EPS is set to rise from 52.7p in 2013 to a forecast 129.9p in 2017.
The 2016 P/E ratio now stands at just 10.45, with a dividend yield of 3.35%. In my view, that's great value for a company growing this fast.
The question is, can the firm maintain this level of growth? Well, at some point the growth will stop, just as happened with Tesco. But we're not at that stage yet and with the consumer economy in emerging markets set to storm ahead, I think Prudential could well be a good place to put your money.
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Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
