The biggest companies aren’t always the best investments. But in many cases, those which have the biggest market share in their sector can be long-term winners.
Simply put, if you sell more of something than anyone else, you can often gain an advantage through lower costs and other economies of scale.
The two companies I want to look at today are both the biggest players in their respective sectors in the UK. Here’s why I’ve been buying them both.
Earnings are growing at 20%
Supermarket group Tesco (LSE: TSCO) has a UK market share of about 28%. That makes it significantly larger than second-placed J Sainsbury (16%) and third-placed Asda (15%).
As if this advantage wasn’t enough, Tesco recent acquisition of wholesaler Booker has enabled the group to move aggressively into the wholesale and catering markets.
Tesco’s turnaround under chief executive Dave Lewis appears to have been very successful. The shares have risen by 7% over the last year and are up by 55% from their 2015 lows. It would be easy to say that the good news is in the price, but I’m not so sure.
The supermarket giant’s headline operating profit rose by 28.4% last year. Analysts’ forecasts suggest this momentum will be maintained in 2018/19 and 2019/20. Adjusted earnings per share are expected to rise by 17% during the current year, which ends on 24 February, and by 20% in 2019/20.
I’ve bought the shares
I think Tesco chairman John Allan and Lewis have done a very good job so far.
Net debt has fallen from nearly £10bn in 2015 to just £3.1bn today. Profit margins are rising steadily and the group’s operating margin reached 2.9% during the first half of the year. I see no reason to question Lewis’s guidance for a figure of 3.5-4% by 2019/20.
Broker forecasts put the shares on a price/earnings ratio of 13.1 for 2019/20, with a 3.4% dividend yield. In my view, this could be a profitable level to buy for long-term investors.
Supersize trend helps lift sales
My largest personal holding in the retail sector is Dixons Carphone (LSE: DC). The owner of Currys, PC World and Carphone Warehouse is in turnaround mode at the moment. But the firm’s stores and online presence still seem to be attracting plenty of shoppers.
During the all-important Christmas trading season, the group’s like-for-like (LFL) sales rose by 1%. UK electricals were 2% higher, with international sales up 5%. Apparently, “the supersizing trend” for larger televisions helped lift sales.
The only area of weakness was UK mobile, where LFL sales fell 7%. New boss Alex Baldock is already working on plans to reinvent the mobile business, which has been hit by the trend for SIM-only contracts and less frequent phone upgrades.
The shares look cheap to me
However, Baldock left guidance for a 2018/19 pre-tax profit of about £300m unchanged today. As a shareholder, I support his plans for selected store closures and a bigger focus on online sales.
With profit forecasts unchanged, Dixons Carphone shares look cheap to me, on a forecast price/earnings ratio of 7.2 for the current year. My sums suggest the dividend is set to fall to about 6.6p, which would give a 4.6% yield. I rate the shares as a buy.