The Tesco share price could cost you dearly from here

The Motley Fool

The Tesco (LSE: TSCO) share price divides opinion across the investment community. So should you buy, sell or hold the stock?

In April when the shares were 237p, I wrote an article arguing that the company is a "falling star in a challenged industry," although I conceded that other investors might see "a turnaround candidate that is turning." I acknowledged the double-digit percentage earnings increases the firm has been posting, and the share-price progress, but thought the valuation was ahead of itself.

A turnaround that turned

Back then the forward price-to-earnings (P/E) ratio for the trading year to February 2020 stood at 14 and the forward dividend yield was near 3%. The share price has moved up over the last two months to around 257p, but I stand by my view in the April article that I think we are seeing a rebound from a catastrophic earnings collapse. The progress in rebuilding earnings seems to be driven by efficiency improvements in the business. I still don't believe that there is a sustainable growth story emerging in Tesco today because of the threat from the rise of discounting competition such as Aldi, Lidl and others, which is disrupting the supermarket sector in Britain.

Am I right to maintain my bearish stance on Tesco when the share price is moving up against me? My Foolish colleague Roland Head said in an article a few days after mine in April that he would "keep buying." He pointed out that chief executive Dave Lewis "knew that fixing the business was essential before it could return to growth." Roland believes that last year's strong results "suggest this turnaround process is now nearly complete." He believes that the integration of the recently acquired Booker wholesale business into Tesco's operations will lead to more growth, although he's not expecting earnings to shoot the lights out as we see with some small-cap firms.

I agree with Roland that the turnaround process looks as if it is nearly complete, which makes me believe the short-term turnaround trade in Tesco stock is probably close to its use-by date. Therefore, I'm expecting the share price to flatline soon. But maybe Tesco is worth buying to hold for the long term in order to collect the dividends? My Motley Fool writing colleague Alan Oscroft posted an article at the end of April arguing against that strategy.

Long-term headwinds

Alan said that Tesco's valuation has been higher than the overall FTSE 100's in the past because of the firm's overseas expansion "and getting its fingers into a number of non-supermarket businesses." Sadly, he concludes that "those days are in the past," which chimes with my view about Tesco today - the glory days are over and I don't think they'll ever return.

Alan reckons Tesco will "get back to paying a steady 3% to 4% dividend." However, he doesn't see that as "worth a premium valuation." He thinks Tesco will likely track the performance of the FTSE 100 so he'd rather invest in a tracker fund than in Tesco. I think the firm is struggling against long-term headwinds in the industry, which could deliver too much downside risk in the years to come. On top of that, there will probably be an opportunity cost if you invest in Tesco instead of going for more vibrant firms.

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Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.