Tesco's recent fortunes illustrate how, like economies, companies move cyclically

Cycle path - Tesco's recent fortunes illustrate how, like economies, companies move cyclically

Andrew Lyddon

26 Jan 2012

We have discussed in the past how the broader economy moves in cycles – and how value investing looks to exploit how the market responds to different points within those cycles. However, the recent profit warning issued by supermarket giant Tesco illustrates how individual industries and even individual companies can have cycles of their own.

Over the last decade or more, Tesco has enjoyed an extraordinary rise from being just one of the food retailing herd to become, by some distance, one of the biggest beasts in the global retail jungle. At present there is no question the group dominates all aspects of retailing in the UK, from convenience stores, through traditional supermarkets and increasingly the online space as well.

Inevitably, when a company finds a formula that brings it as much success as Tesco has enjoyed in the UK, natural economic forces begin to assert themselves – perhaps, for example, the competition learns from what a winning business has done, or maybe some of the people at the top of the winning business grow so used to success that a bit of complacency slips in. Either of those factors and no doubt plenty of others could have come into play at Tesco in recent years to slowly chip away at the lead it had established from rivals.

Just as value investors will seek to take advantage of extremes of valuation thrown up by economic cycles they will also look to do so with an industry or company-specific cycle. Businesses go through phases of good and bad operational performance and of being liked and disliked by the stock market, indeed until quite recently Tesco has been a relatively loved company.  The negative reaction to its recent setback may turn out to be much more extreme than is actually justified as even if Tesco is no longer the supermarket winner in the UK that does not mean it has become a bad business overnight.

In all probability and provided its management behave sensibly, Tesco can still earn good returns in the UK and operates a large foreign business that has further to grow. Even if the next 10 years does not see it scale the heights of the previous decade relative to competitors, investors who can find the right entry point in terms of valuation could still make good returns from its shares.

http://www.thevalueperspective.co.uk/tvp/archive?id=Cycle%20path%20-%20Tesco's%20recent%20fortunes%20illustrate%20how,%20like%20economies,%20companies%20move%20cyclically