Last Updated February 24, 2014
In 2012 Tesco PLC announced its first profit warning in 20 years. Immediately, Tesco’s shares fell off a cliff. The Sun newspaper said it all: “Tesco profits warning wipes £4.3bn off company”. The question is, were those investors right to sell?
One of the basic principles of value investing is that you are looking to buy shares when they represent good value for money. In most cases this means you buy after the shares have fallen, which is the opposite of what most people want to do.
After all, who wants to buy an investment that’s going down?
Most people would say they wouldn’t, which is why value investing remains a niche activity, but a profitable one.
I have written a review of Tesco’s shares before, shortly after the profits warning and on the exact same day that Warren Buffett upped his stake in Tesco to 5%. It’s a company that I often use as an example of what a defensive investment looks like.
A few months later I joined Buffett as a shareholder, although with slightly less than 5% to my name. You can see how the shares have done from just before the profits warning until today in the chart below:
When the profits warning came Tesco’s shares were trading at about 385p each, and by the time the market had finished panicking they had fallen all the way down to 312p. A drop of almost 19% in a couple of days is certainly not what most defensive and income focused investors sign up for.
When I bought in June 2012 I allocated Tesco a 3% slot in my portfolio (both my personal pension and the UKVI model portfolio) at the slightly lower price of 300p.
My decision was based on Tesco’s long-proven ability to generate a growing stream of sales, profits and dividends, combined with a dividend yield of 4.9% and a very low price relative to the company’s past earnings.
In other words it was a defensive company being sold at a “value” price.
Tesco’s shares have now been in the portfolio for almost 16 months, so what have the returns been for those shares, given that the company was “reeling”, “in crisis” and it’s “crown had slipped”, according to various media reports?
So far the model portfolio has received 4.9% in dividends and the shares have appreciated by 18.8% (to a share price of 361p as I write). That gives a total return of 23.7% and annualised gains of 18.1% per year.
Unless you Warren Buffett that’s not a bad return at all from an apparently struggling blue-chip company.
Although looking at short-term performance (anything less than 5 years) can be a dangerous game, I think Tesco’s profit warning is a good illustration of how the future is far more uncertain than most people think. The profit warning itself was unexpected, and the share price gains after the initial panic were also unexpected.
The Great Tesco Profit Warning Panic is also a reminder that buying successful companies when everybody else is selling is a sound basis for a sensible investment strategy (especially when you’re on the same side of the deal as Warren Buffett).