Why Buffet Called Tesco (TSCO) purchase ‘Huge Mistake’?

Originally known as UK based grocery store chain, from the 1990s Tesco started to expand outside Britain. By 2010 the company had stores in 11 countries. The company focused heavily on building consumer loyalty, by introducing a club card. This essentially gave customers a 1% cash-back on all purchases. The company has also expanded into other businesses as well. Tesco Bank started offering higher interest rates on savings accounts in order to attract more clients. While at the same time, Tesco mobile also provided customers with quite affordable rates.

The successes of this business were also noticed by Warren Buffet, who started purchasing its stock in 2006. By 2011, he raised his stakes to more than 5% of the company’s outstanding shares. At the same time, Tesco shares have risen significantly. Increasing from just 100p (£1.00) in the late 90s to over 400p (£4.00) by 2010. In 2011, the annual dividend paid to shareholders has reached 14.76p per year. So besides an impressive history of capital appreciation, the company also had a dividend yield of more than 3.5%. This was quite attractive, especially in times of near-zero interest rates.

Overextension or General Mismanagement?

                                                                                                                                                       Source: google.com

As we can see from this chart, it all went downhill from 2011. The first major collapse of share price came as the company issued the first profit warning, followed by several others. By 2010 to 2015 the company has moved from making more than £3 billion profit in a year to record £6 billion loss in 2015. Some commentators blamed the firm’s decline to overextension. For example, Tesco’s attempt to establish its regular presence in the US was an expensive failure. It’s subsidiary Fresh&Easy struggled for years, before it was closed down in 2013. The total cost of this one failure alone was £1.8 billion.

Warren Buffet started selling Tesco shares in 2014, followed by additional liquidations in 2015 as well. In an annual meeting to shareholders, he stated: “An attentive investor, I’m embarrassed to report, would have sold Tesco shares earlier. I made a big mistake with this investment by dawdling.” The total loss from this operation has amounted to $444 million. This only represented 0.2% of Berkshire Hathaway’s net worth. However, at the same time, this was the largest loss in the company’s history.

Are Tesco Stock Now Better Deal?

After closing down several unsustainable subsidiaries, the firm also changed its leadership. New CEO, a former high-level executive at Unilever, took over the company in September 2014. The company struggled to recover for years, however recent announcements seem more encouraging. According to the 2019 annual report, Sales increased by 11.5% to £56.9 billion, while profit rising by 34% to £2.2 billion.

However, it might be too early to speak about Tesco regaining the confidence of the market. Stock price still struggles to get above 300p. The company slashed dividends to zero in 2015 and 2016. From the next year, the firm resumed paying dividends, but it was set to just 3p per year. Recently, Tesco increased its annual payouts to shareholders to 5.77p.

So in a sense, we can conclude that the company is on the road to recovery. However, it’s P/E ratio is still above 23, so this might suggest that this stock compared to its earnings, might be a bit expensive.