Should you be buying Tesco plc and Next plc after recent sell-off?

Today I'll be discussing the outlook for multinational retailing giants Tesco(LSE: TSCO) and Next(LSE: NXT). Would it be wise to go against the herd and invest in these two FTSE 100 companies after recent declines?

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Punished enough

Fashion retailer Next has suffered at the hands of the market in recent months, falling from highs of around £80 in December to recent lows below £50 earlier this month. Full-year results for the twelve months to the end of January revealed a 5% rise in pre-tax profits to £836m, compared to £795m a year earlier, with revenues up from £4bn to £4.2bn.

But it was the gloomy outlook that spooked the markets, with management sounding downbeat about the prospects for 2016, citing uncertainty around the global economy and suggesting that trading conditions would be the toughest since 2008.

The shares fell off a cliff, losing around 15% of their value on the day of the announcement. In a further trading update earlier this month the Leicester-based retailer revealed that first quarter sales for fiscal 2017 had dropped slightly as a result of unseasonably cold weather affecting demand for spring clothing.

I believe the shares have been punished enough and now look oversold. Market consensus suggests that earnings will remain broadly flat this year with underlying profits coming in at around £660m, followed by a 6% rise to £696m for fiscal 2018.

This would leave the shares trading on 12 times forecast earnings for this year, falling to just 11 times for the year to the end of January 2018. Dividends payouts remain attractive with prospective yields of 3.6% and 3.4% forecast for the next two years.

Rising competition

It's been exactly one month since Tesco's results were announced for the year ending February 2016. The UK's biggest retailer swung to a pre-tax profit of £162m, compared to a record-breaking £6.4bn loss a year earlier. But underlying earnings were down 64% to 3.42p per share, with revenues also in decline, falling from £62.3bn to £54.4bn.

Fears of increased competition and a cautious outlook have led to the shares losing a fifth of their value since the results were announced a month ago. Despite the negative sentiment, analyst forecasts point to a strong recovery in the medium term. Our friends in the City have pencilled-in a massive 146% hike in earnings for the year to February 2017, with a further 40% improvement earmarked for fiscal 2018.

For a company facing rising competition from the likes of Aldi and Lidl, as well as traditional rivals such as Asda, Sainsbury's and Morrison's, I feel the forecasts are far too optimistic and could be subject to further downward revisions in the months ahead.

The verdict

Next shares look oversold to me, as I believe the market has over-reacted to the management statement in March. Value investors could go against the herd and buy into a British success story at a beaten-down price.

Tesco looks like a riskier recovery play to me given the higher P/E rating. The shares still look pricey even after the optimistic growth forecasts have been factored-in. If next year's results fall short of these estimates, the shares are likely to sink further.

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Bilaal Mohamed 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.