Tesco (LSE: TSCO) shares have fallen by 42% so far this year — further than both J Sainsbury (LSE: SBRY) — down 29% — and Wm. Morrison Supermarkets (LSE: MRW), which is down 33%.
Despite this, Tesco is still more expensive than its rivals on some key measures, as I’ll explain in this article.
1. Book value
Book value — or a company’s theoretical sale value — is important, especially for firms with large property portfolios, low profit margins, and physical stock inventories, such as supermarkets.
|
|
Tesco |
Sainsbury |
Morrisons |
|
Share price (24/09/14) |
193p |
260p |
175p |
|
Price/book value |
1.06 |
0.83 |
0.87 |
|
Price/tangible book value |
1.42 |
0.87 |
1.0 |
From these figures, it’s clear that Sainsbury’s is currently the cheapest supermarket, trading at just 83% of its book value.
2. Trade price
Professional investors and trade buyers usually prefer to value firms using the EV/EBITDA ratio, rather than P/E.
EV/EBITDA stands for enterprise value (market cap plus net debt) divided by earnings before interest, tax, depreciation and amortisation (EBITDA).
In my view, EV/EBITDA is a very useful measure for private investors, as it enables you to compare the valuation of firms with different debt levels:
|
|
Tesco |
Sainsbury |
Morrisons |
|
EV/EBITDA |
5.6 |
4.0 |
6.9 (forecast) |
On this measure, Sainsbury’s is a clear winner, with a very low EV/EBITDA ratio of 4. Tesco also looks affordable, on 5.6.
Morrisons traded at a loss last year, making a calculation impossible, but assuming the firm’s full-year figures are in line with this year’s interim results, Morrisons trades on a EV/EBITDA ratio of 6.9, making it the most expensive of the bunch.
3. Return on capital
Another valuation metric that’s favoured by professional investors is return on capital employed (ROCE) — the return the company generates from its equity and debt capital.
This can be calculated as operating profit / (equity plus debt).
ROCE is an important measure of how profitable a company really is, and enables you to see whether your money could generate a better return elsewhere.
|
|
Tesco |
Sainsbury |
Morrisons |
|
Return on capital employed |
9.2% |
10.3% |
7.7% (forecast) |
Again, Sainsbury’s scores highest, Tesco second, and Morrisons last, based on last year’s reported figures from Tesco and Sainsbury’s, and this year’s first-half figures from Morrisons.
Which should you buy?
Both Sainsbury’s and Tesco have yet to report their interim results. I expect both to report lower profits than for the same period last year, but Sainsbury’s discount to book value gives it the edge as a buy, in my view.
Morrisons is the only firm that’s in the clear at the moment, as its first-half results were as expected and, in my view, cautiously positive, so I retain my buy rating on the stock.