The 4% gain so far this year in the Tesco (LSE: TSCO) share price is decent. But lately Tesco shares have been drifting a bit. Trading for a bit over £5 back in February, they are now down to around £4.60.
Might they move higher and break through the £5 level again? Or could the recent weakness potentially be the start of a longer-term move downwards?
A business with lots of strengths…
Given that stock markets have had a good run of it in the past several years, it may be surprising that Tesco shares have performed well.
After all, supermarkets are often seen as a defensive pick that tend to grab investors’ attention more when markets are not doing so well.
But over the past year, Tesco shares have moved up 19% — nearly as good as the 20% increase seen in the FTSE 100 index over that period.
Over five years, the retailer’s shares have performed even better. The Tesco share price has more than doubled in the past five years, compared to a 50% gain for the FTSE 100 during the period.
That may be in part because of the strengths Tesco has.
It is the UK market leader by a considerable distance. That offers the chain economies of scale, a huge customer base, and a prominent place in people’s minds when they think about shopping for groceries, whether instore or online.
…but also ongoing challenges
Alongside Tesco’s strengths, though, it is also worth thinking about some of the challenges it faces.
The UK grocery market is intensely competitive. That is set to get even worse over time, as discounters like Aldi and Lidl continue to expand.
That has led rivals including Tesco to pay more attention to keeping pricing keen, an ongoing risk to profit margins.
Inflation is rearing its head again in supply chains and higher shipping costs could push up the cost of importing. Meanwhile, Tesco is dealing with other increases in its cost base – as a large employer, growth in wages and National Insurance costs have added to its outgoings.
I’m not ready to invest
Still, this is a well-run, proven business that I see as having ongoing potential.
If investor momentum remains high, I think that could push Tesco shares above £5 again. That would be a 9% increase, which though substantial is possible over the course of a few months, as the 12-month share price growth I discussed above demonstrates.
Good trading news could also help boost the shares, for example if Tesco announces that hot weather is seeing demand for barbecue items, ales, ice lollies, and sunshades soar.
My concern, though, is about whether the price might go the other way.
Tesco shares already sell for 17 times earnings. That might not seem expensive for such a high-quality business: indeed, it is exactly in line with the price-to-earnings ratio of rival J Sainsbury.
But I do not see that as an attractive purchase price for a supermarket, even a well-run one. The industry is highly competitive and profit margins are razor thin.
So I will be looking at other UK shares to buy for my portfolio.
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Christopher Ruane does not hold any position in the companies mentioned.
