With the UK facing a cost of living crisis, its a natural time to be looking at the shares in companies like Tesco (LSE:TSCO) and Sainsbury (LSE:SBRY). Even if we are likely to hold off buying a new car, we’re unlikely to stop doing our weekly shopping.
Billionaire investor Warren Buffett says that investing is about looking for quality businesses at fair prices. Do shares in either Tesco or Sainsbury fit the bill?
Quality
When looking for a quality investment, Buffett looks for a business that can gain a strong return on its tangible assets. In order to evaluate for Tesco and Sainsbury, I’ve measured each company’s operating income as a percentage of its net property, plant, and equipment.
Since any company can have an unusual year, I’ve calculated this for each of the last four years. Here are the results:
| Return on Property, Plant, and Equipment | 2022 | 2021 | 2020 | 2019 |
|---|---|---|---|---|
| Tesco | 11.41% | 10.82% | 10.02% | 10.92% |
| Sainsbury | 8.28% | 0.45% | 4.73% | 3.21% |
From this, Tesco is a clear winner. While Sainsbury has been showing improvements (aside from an unusual year in 2021), Tesco has consistently been generating stronger returns. From a quality perspective, then, I think Tesco shares are clearly more attractive.
Value
The next question is which one trades at a more attractive price.
The current level of Tesco’s stock prices the company at just under £21bn. On top of this, the company has £15.4bn in debt. The business also has £2.3bn in cash and generates £2.6bn in operating income. From an investment perspective, this means a return of 7.6%.
The Sainsburys share price implies a total valuation of £5.6bn It has a further £7.4bn in debt and £807m in cash. It’s generating around £1.2bn in operating income, which implies an investment return of 9.5%.
Sainsbury, therefore, has around half the debt, half the cash, and generates around half the income of Tesco. But its share price values the entire business at around a quarter of the price implied by Tesco’s shares. As a result, Sainsbury shares are more attractive from a valuation perspective.
Conclusion: Tesco shares vs Sainsbury shares
By these standards, Tesco has the better business and Sainsbury has the more attractive price. Which one would I buy today, given the choice?
In a steady sector where demand is unlikely to fluctuate much either positively or negatively, it’s hard to find investments with really significant upside. In my view, that’s the major risk with these stocks. That leads me towards preferring Sainsbury for my portfolio.
While Tesco has the more efficient operation, Sainsbury has been improving its returns on tangible assets over the last few years. If it can continue to improve in this regard, I think the stock can do well.
In addition, Sainsbury has more upside as far as valuation is concerned. The stock currently trades at a lower multiple than Tesco stock, giving it more room to trade higher in the future.
