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Warren Buffett wouldn’t buy Tesco shares today. Neither would I

Edward Sheldon, CFA
·3-min read
close-up photo of investor Warren Buffett
close-up photo of investor Warren Buffett

Warren Buffett once bought Tesco (LSE: TSCO) shares for his investment company, Berkshire Hathaway. It was an expensive mistake. He eventually sold the shares. But not before losing hundreds of millions of dollars on the stock.

Would Buffett be interested in Tesco shares today? I doubt it. The company has come a long way in recent years. However, it’s still not the kind of high-quality company that Buffett goes for. Let me explain.

Why Warren Buffett wouldn’t buy Tesco shares

One of the first things Warren Buffett looks for in a company is a competitive advantage, or ‘economic moat’ as he likes to say. This is some form of advantage that gives a company an edge over its rivals. It keeps customers coming back and protects market share.

These days, Tesco lacks a competitive advantage. There’s nothing to stop a consumer from shopping at a rival. This is well illustrated by supermarket data. In recent years, Tesco has lost a significant amount of market share to rivals such as Aldi, Lidl, and Ocado.

Buffett likes big profits

Another thing Buffett likes is a high level of profitability. He likes businesses that can generate a high return on the money put into the business. Profitability can be measured with ratios such as return on capital employed (ROCE) and return on equity (ROE). The higher a company’s profitability, the more money it will have to reinvest for future growth, and reward shareholders.

Tesco’s ROCE is quite poor. Over the last five years, it has averaged just 6.3%. That means it’s not very profitable. By contrast, Unilever – which Warren Buffett tried to buy a few years ago – has averaged a ROCE of 23.8% over the last five years. Meanwhile, Apple, which is Warren Buffett’s top holding, has averaged a ROCE of 27.4%.

Buffett hates debt

Buffett also likes companies that have strong balance sheets. He doesn’t like a lot of debt on the books. Debt makes a company more vulnerable during challenging periods.

In Tesco’s half-year results yesterday, the company advised that it had net debt of £12.5bn at 29 August. That’s quite high. By contrast, total equity was £12.2bn.

It’s worth pointing out that according to Stockopedia, Tesco has a Altman Z2 score (this measures financial health) of 0.69. This indicates a ‘serious risk of financial distress’ within the next two years.

Tesco shares: Buffett would say no

Finally, Buffett likes value. Currently, Tesco shares sport a forward-looking P/E ratio of 15.8. That’s not particularly high, however, it’s also not a bargain valuation. It’s in line with the P/E ratio of the FTSE 100 index. I don’t think Buffett would get excited about that valuation.

All things considered, I’m pretty sure Warren Buffett would put Tesco shares in his ‘No’ pile today. Tesco simply just isn’t a high-quality business.

Tesco is in my ‘No’ pile, too. I think there are much better stocks to buy today.

The post Warren Buffett wouldn’t buy Tesco shares today. Neither would I appeared first on The Motley Fool UK.

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Edward Sheldon owns shares in Unilever and Apple. The Motley Fool UK owns shares of and has recommended Apple. The Motley Fool UK has recommended Tesco and Unilever. 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.

Motley Fool UK 2020