Is Tesco stock too expensive?

The share price of FTSE 100 supermarket Tesco (LSE: TSCO) remained stubbornly unmoving in the past, despite the fact that there is a whole lot going for it, to my mind. But not in the last three months. Its share price has risen 7.7%. 

How does it compare to the FTSE 100?

This is not just a share price increase in absolute terms though. It is also one in relative terms. As a result, its price-to-earnings (P/E) ratio now stands at around 25 times. 

I use the P/E often to understand better how the stocks I like are priced against each other. It is also helpful in assessing where they can head in the future. Knowledge of the ratio for the FTSE 100 index as a whole is particularly handy in conducting this exercise. It is at around 15 times at present. 

This means that the Tesco share price is much higher than that of the index as a whole. Does this mean that it is pricey? Not necessarily, I feel. While other companies have struggled in the past year as coronavirus infections wreaked havoc, the supermarket actually made gains. 

Why the Tesco share price is high

And this was not only because grocers were still in business or we were buying more household products. The company also stepped up its home delivery service. As a regular user of this service, I can vouch for it. The point I am underlining here is that Tesco made the most of the opportunity that presented itself, which could just as easily have been squandered.

Also, I see supermarket stocks as good defensive shares. Their fortunes do not change dramatically in recessions, and are good to hold in uncertain times. As the economy is not out of the woods yet and some coronavirus risks could still derail progress, I can see why the company’s share is priced higher in relative terms. 

It also has a dividend yield of 4.3%. This is not the highest yield around, but it is higher than the average FTSE 100 yield of 3.3%. One way to look at this is that it may have a higher-than-average share price, but it also has a higher-than-average dividend yield. So that does make up for a higher P/E to some extent.  

What I’d do now

I think that there is a possibility that its share price may ‘correct’ a bit. As the economy becomes stronger, cyclical stocks should start showing better results. Indeed, this is already becoming evident in incoming updates. Defensives can fall out of investor favour to some extent in such an environment. 

But then again, I think financially healthy defensive shares are good to hold for the long term. In market economies like ours, slowdowns are a part of our ongoing reality, against which the likes of Tesco can be a good hedge. Especially with its dividend yield, I am not complaining and would buy it today.