What are the long-term prospects for Tesco Plc (LON: TSCO)?

I'm always searching for shares that can help ordinary investors like you make money from the stock market.

Right now I am trawling through the FTSE 100 and giving my verdict on every member of the blue-chip index.

I hope to pinpoint the very best buying opportunities in today's uncertain market, as well as highlight those shares I feel you should hold... and those I feel you should sell!

I'm assessing every share on five different measures. Here's what I'm looking for in each company:

1. Financial strength: low levels of debt and other liabilities;

2. Profitability: consistent earnings and high profit margins; 

3. Management: competent executives creating shareholder value;

4. Long-term prospects: a solid competitive position and respectable growth prospects, and;

5. Valuation: an under-rated share price.

A LOOK AT TESCO

Today I'm evaluating Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US)], a British multinational retailer, which currently trades at 363p. Here are my thoughts:

1. Financial strength: Tesco is in solid financial position.  Net debt/operating cash flow is less than 2 times; net gearing is 50%; interest cover is an adequate 7.5 times; and free cash flow has averaged nearly £2bn per year over the last 3 years.

2. Profitability: Tesco has delivered outstanding growth for nearly two decades. However, with the continuing weakness in Europe and facing stiff competition at home, the company has struggled of late. In the last fiscal year, underlying profit before tax declined by 15% while underlying earnings per share fell by 14%. Forced to compete in price, the company's margins have contracted from to 3.4% from 5.6% the previous year.

Also, international trading profit declined by 22%, due to the impact of regulatory changes in South Korea and impairment of businesses in Turkey, Poland and the Czech Republic.

3. Management: I believe the company's new direction under Philip Clarke, which focuses on developing its "multichannel" footprint, strengthening its core UK business, and adopting a more prudent international growth strategy,  places the company in a better position moving forward.    

4. Long-term prospects: Tesco has fallen out of favour with investors recently after a rough 18 months where it was rocked by the horsemeat scandal, several quarters of declining market share and like-for-like sales, and write-offs of its Fresh and Easy US business and several UK properties of more than £1bn  and £804m, respectively.

However, despite the grim outlook, I believe Tesco's competitive position remains solid. It is still the largest UK grocer with a market share of 30% --almost doubling that of its closest rival Wal-Mart's ASDA. It also owns the UK's widest store network with around 3,000 stores and the world's largest and most profitable online supermarket, which reached a record-high revenue of over £3bn last year. In addition, it is the number one or two retailer for general merchandise in 8 out of 9 of its international markets.

Furthermore, to adapt to the rapidly changing retail environment, the company has announced new strategic objectives which include: a shift from traditional large-store formats to building its "multichannel" retail capabilities such as convenience and online retailing; focusing on its core UK operations to maintain its leading position -- the company has invested around £1bn to overhaul its superstores; and adopting a more disciplined approach to international expansion, concentrating only on markets that could deliver strong investment returns. 

5. Valuation: With a market cap of £30bn, Tesco trades at a forward price-to-earnings (P/E) ratio of 11 -slightly below its 10-year median P/E of 13 and the industry average of 12-- and a prospective dividend yield of 4%, twice covered.

My verdict on Tesco

Although recent results have been disappointing and with competition in the UK likely to remain competitive, I think the company still owns a distinct advantage with its scale and size. Also, its profitable international business --29% of the company's profits come from outside the UK--  and established online presence could be a source of future growth opportunities.

Moreover, the company intends to tighten capital spending during the next few years --around 3.5% to 4% of revenue-- which will add to its already strong cash flow. What's more, shares are trading at an undemanding P/E of 12, a discount compared to its peers Wal-Mart andCarreouflour.        

So overall, I believe Tesco at 363p looks like a buy.

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Munger:"Cognitive Failure" in Economics

"Alan Greenspan at the Federal Reserve overdosed on Ayn Rand. Basically he kind of thought anything that happened in the free market, even if it was an axe murder, had to be ok. He's a smart man and [a] good man, but he got it wrong. Generally, an over-belief in any one ideology is going to do you in if you extrapolate it too hard, and that's what happened in economics."

So, according to Munger, what caused this "cognitive failure" in economics?

"They reasoned correctly that a free market would be way more predictive than anything else, and they reasoned correctly that once you had a fairly advanced capitalist system – if the people that were putting up the capital could sell their pieces of ownership in the company to other people, they'd be more inclined to invest because it gave them an option to get out if they wanted to leave. It's not like buying a restaurant in the wrong place. Then they reasoned that if that was true, if you had a really free, liquid, wonderful market in securities, that would be wonderful, and the bigger and more wonderful it was, the better it was for the wider civilization."

Having a million shares trade in a day was a rare occurrence when Munger attended Harvard Law School. Now billions of shares trade each day. He guesses that those who think along these lines are probably looking forward to when trillions of shares will trade in a day. Munger then adds...

"Our civilization is not going to work better if we have trillions of shares traded everyday. It's the most asinine idea you could ever have to extrapolate so vigorously, and of course three or four billion shares is way too many. We have computer programs that are trading with other computer programs. We have many of the bright people who ought to be doing our engineering going to work at hedge funds and investment banks and algorithmic trading places and so on and so on."

Munger goes on to say "at any rate, these people got the idea [that] unlimited trading is a big plus for civilization."

Well, John Maynard Keynes certainly thought otherwise as Munger further explains: 

"[Keynes] said a liquid market of securities is one of the most attractive gambling devices ever created. It has all the joy of gambling, plus it's respectable. Furthermore, instead of being a zero-sum game, where you are bound to lose the frictional cost, it's a game where you can pay the frictional cost and actually make a profit. This is one of the most seductive gambling devices ever invented by man, and some nut who took economics thinks that the bigger and better it gets, the better it is for wider civilization."

Now, consider that speaking to Forbes back in 1974, Warren Buffett described the business of investing in the following manner:

"I call investing the greatest business in the world...because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! And nobody calls a strike on you. There's no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it."

Investing can certainly be a great business but all this hyperactivity is directly at odds with the reasons why.

Compared to all this rapid trading of price action, waiting patiently for something you understand to get cheap enough, then owning it for a very long time, is a completely different game.

Modern capital markets are an incredibly convenient way to buy part of a good business that's priced attractively with minimal frictional costs. 

To me, it seems quite the shame to see something so incredibly useful and powerful converted into a casino; see it turned into something less than it otherwise might be.*

So more of something doesn't automatically make it better. There's often optimal amount -- at least within some range -- and, of course, diminishing returns or worse. Some short-term oriented speculative activity is necessary and even desirable. That doesn't logically mean that unlimited amounts of it is a good thing. 

The amount of speculation relative to investment matters and the former is currently swamping the latter. What John Bogle describes as The Triumph of Speculation over Investment.

There may not be a precisely knowable correct ratio of speculation to investment, but I think it's safe to say we are far from what makes sense. I've used the petrol engine as a simple -- even if a limited and imperfect one -- example of this. 

The petrol engine just doesn't function all that well if the air-fuel ratio strays too far from what's optimal (and, eventually, it won't function at all if there's too much of either substance).

As with most any system, even what is a comparably simple one, the proportion matters rather a lot.

If efficiently and effectively allocating capital and strong long-term business performance are the primary goals then, in their current hyperactive form, the equity markets seem likely to have far from the optimal ratio of speculation relative to investment.

Check out the entire conversation with Charlie Munger at Harvard-Westlake. 

Lots of useful thoughts and insights.

That 1974 Forbes article is a pretty worthwhile read too even if not exactly breaking news.

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Investing is NOT Speculation

There is a difference between speculation and investing.  

One distinction defined this by the length of time over which the investor expects to realise their investment; or to put it another way, how quickly one expects to make money.  

Speculation is high-risk-get-rich-quick territory. 

Investing is managed risk over long periods of time where you can acquire wealth slowly.  

[  I am an investor by nature, not a speculator.
I am in it for the long haul, and having bought many good shares at fair or bargain prices in the past and presently, I intend to hang onto to them.
My view is that they will move yet higher over time.
Sometimes, the massive and largely unprecedented increase in the share price of my stocks over a short period was not anticipated by me or probably by many others.
So, did I get lucky?  Well, yes and no.
It was my view that the share price of these companies would rise further or eventually recover from recent corrections, whilst the past is no way of accurately predicting the future, I felt that it would rise to around a certain price in the medium term. 
The difference between my expectations and what happened is that I would have been happy for it to return to that price within five years.  As it happened, it did so in less than a few months.  ]

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The more debt you take on, the higher the risk

The higher the net gearing figure, the riskier the investment becomes.  This is basically because debt has to be paid back no matter what happens to your sales.  Costs are generally more fixed, whilst income for most businesses is variable and can fluctuate wildly.  

For example, the manufacturer of high-end electronic consumer goods that is very heavily geared is likely to face a potentially serious problem in the event of a sudden economic downturn.  The debt, however, as a fixed cost, would remain. This is how large numbers of businesses go under.

A business in the same sector with little or no debt and a healthy bank balance is far more likely to weather the economic storm.  Recessions are nothing new, they have happened before and will do so again.

Does any business really have an excuse for not being prepared for them?  



[So the world will almost certainly face further financial shocks and economic events that will surprise us, and whilst we can't say when it will happen or how exactly it will play out next time around, sometimes it really can feel like a little bit of history repeating as the stock market will continue to behave in both a rational and irrational manner without warning. 

That is why it is so important to think about the business, and not the share price or even what the market is really doing at all.]

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Saving for Chidren Education

Just want to start off with two paragraphs of some vital statistics

Of the 41,573 public university enrolments this year, only 7,913 were Chinese Malaysians. Last year Chinese students made up 8,985 of a total enrolment of 38,549 and in 2011 around 9,457 of a total enrolment of 41,267, according to the Malaysian Chinese Association, or MCA, which is part of the Barisan coalition. 

http://www.universityworldnews.com/article.php?story=20130717110401762

Datuk Dr. Mohd Nor Dalimin, Malaysian Examinations Council chairman announced that a total 46,712 or 92.19 per cent had full passes for at least one subject in the Sijil Tinggi Persekolahan (STPM) 2011 compared to 46,795 (92.5 per cent) in 2010, 0.31 per cent drop. 12 candidates received the excellent A grade in five subjects taken compared to eight candidates in 2010. A total of 50,669 candidates had sat for the STPM last year.

http://www.yusufmustanir.com/2012/03/stpm-road-to-university.html

If you are a Chinese Malaysian, you should know that the chance of your child or children getting into public university is less than 20%. You should also know that you should get ready at least about RM 120 k per child down the road if you wish them to be able to study in a reputable local private college.

Tuition fees will cost you around RM 70 k for a 3 years course. The cost of living includes lodging, food, transportation, telecommunication, etc will easily cost you another RM 50 k/3 years.

For those of you who are young, let's say you have 19 years to prepare the RM 120 k How much do you need to put aside if you can generate 5% return per year? I use lower % return partly just to offset the inflation. To get 5% inflation adjusted return in a new normal investing environment, I must say you must be above average investors as well. But never mind, let's move on to the calculation.

If you start with RM 1 k in year 1, CAGR return of 5%, to save RM 120 k - you will need to set aside RM 3.58 k per year or roughly about RM 320/month per child.

For Chinese Malaysian parents, you should know that 80% chance of not able to secure a place in public university is not a good odd. Procrastinating will make matter worse unless you want to burden your child/children with loans hanging on their neck before they can earn. Basing on Malaysia per capita income of USD 10 k or roughly RM 31 k, you will need to set aside about 13% of income for future a child education.

Putting uncontrollable factors such as unfairness or free education for every child debates aside, let's get realistic and pragmatic -- control your destiny or someone will. It is this kind of spirit that makes the minority ethnic of this country to seek economic independence. It forces them to be far sighted and working a lot harder.

This is also precisely why the society disparity is getting wider - willingness to prepare financially will ensure their child/children get better education quality or better still if they are bright - Singapore and many other foreign countries will take them as their citizens.

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The Most Hated Bull Market Ever

Life has been challenging for the bears over the last four years. For the first few years of the recovery (2009-2010) when stocks vaulted +50%, supposedly we were still in a secular bear market. Back then the rally was merely dismissed as a dead-cat bounce or a short-term cyclical rally, within a longer-term secular bear market. Then, after an additional +50% move the commentary switched to, “Well, we’re just in a long-term trading range. The stock market hasn’t done a thing in a decade.” With major indexes now hitting all-time record highs, the pessimists are backpedaling in full gear. Watching the gargantuan returns has made it more difficult for the bears to rationalize a tripling +225% move in the S&P 600 index (Small-Cap); a +214% move in the S&P 400 index (Mid-Cap); and a +154% in the S&P 500 index (Large-Cap) from the 2009 lows.

For the unfortunate souls who bunkered themselves into cash for an extended period, the return-destroying carnage has been crippling. Making matters worse, some of these same individuals chased a frothy over-priced gold market, which has recently plunged -30% from the peak.

Bonds have generally been an OK place to be as Europe imploded and domestic political gridlock both helped push interest rates to record-lows (e.g., tough to go lower than 0% on the Fed-Funds rate). But now, those fears have subsided, and the recent rate spike from Ben Bernanke’s “taper tantrum” has caused bond bulls to reassess their portfolios (see Fed Fatigue). Staring at the greater than -90% underperformance of bonds, relative to stocks over the last four years, has been a bitter pill to swallow for fervent bond believers. The record -$9.9 billion outflow from Mr. New Normal’s (Bill Gross) Pimco Total Return Fund in June (a 26-year record) is proof of this anxiety. But rather than chase an unrelenting stock market rally, stock haters and skeptics remain stubborn, choosing to place their bond sale proceeds into their favorite inflation-depreciating asset…cash.

Crash Diet at the Buffet

I’ve seen and studied many markets in my career, but the behavioral reactions to this most-hated bull market in my lifetime have been fascinating to watch. In many respects this reminds me of an investing buffet, where those participating in the nourishing market are enjoying the spoils of healthy returns, while the skeptical observers on the sidelines are on a crash diet, selecting from a stingy menu of bread and water. Sure, there is some over-eating, heartburn, and food coma experienced by those at the stock market table, but one can only live on bread and water for so long. The fear of losses has caused many to lose their investing appetite, especially with news of sequestration, slowing China, Middle East turmoil, rising interest rates, etc. Nevertheless, investors must realize a successful financial future is much more like an eating marathon than an eating sprint. Too many retirees, or those approaching retirement, are not responsibly handling their savings. As legendary basketball player and coach John Wooden stated, “Failing to prepare is preparing to fail.”

20 Years…NOT 20 Days

I will be the first to admit the market is ripe for a correction. You don’t have to believe me, just take a look at the S&P 500 index over the last four years. Despite the explosion to record-high stock prices, investors have had to endure two corrections averaging -20% and two other drops approximating -10%. Hindsight is 20-20, but at each of those fall-off periods, there were plenty of credible arguments being made on why we should go much lower. That didn’t happen – it actually was the opposite outcome.

For the vast majority of investing Americans, your investing time horizon should be closer to 20 years…not 20 days. People that understand this reality realize they are not smart enough to consistently outwit the market (see Market Timing Treadmill). If you were that successful at this endeavor, you would be sitting on your private, personal island with a coconut, umbrella drink.

Successful long-term investors like Warren Buffett recognize investors should “buy fear, and sell greed.” So while this most hated bull market remains fully in place, I will follow Buffett’s advice comfortably sit at the stock market buffet, enjoying the superior long-term returns put on my plate. Crash dieters are welcome to join the buffet, but by the time they finally sit down at the stock market table, I will probably have left to the restroom.

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Chinese inflation – unreported retail

China’s inflation print for June at 2.7 percent, a four-month high, was higher than forecast, but part of the picture could be obfuscated by a lack of accounting for the ever-growing online retail sector.

Gross domestic product figures have been consistently revised down this year from 8 percent to around 7.4 percent by July, with significant doubt over the reliability of official data. Some analysts forecast the more likely GDP print is around 5 percent, given the lack of punishment for falsifying local data and incentives for better growth figures for regional prints.

With an increasing share of shopping carried out online through websites such as Taobao,Tmall and Paipai, there is an increasing argument for online retail numbers -which had lifted one metric of inflation  closer to 7 percent in April –  to be included in the headline CPI. That metric is the retail sector’s internet shopping price index (iSPI).

This includes (based on the compilation of Taobao sales data) food, tobacco, liquor, clothing, household equipment and maintenance services, health care and personal products, transport and communications, entertainment and educational products and services including residential and office supplies. If inflation were calculated on this basis, it could be more accurately computed at 3.15 percent today.

On the connection between the iSPI and the CPI numbers, analysts at ICBC have said:

Network retail price index (iSPI)…  should generally reflect changes in the general price of the domestic online retail channels, which is ultimately the formation of a national network of retail price index and even the formation of the first stepping stone in the CPI process of covering the online retail channels.

Take a look at this chart for a closer look at the level where inflation could be more accurately estimated. In recent months, the gap between the internet shopping index and official CPI data has started to converge, to around 3.65 percent today from as wide as 11.9 percent in May last year.

Online retail holds opportunities for the investor too. According to McKinsey & Company research in March,  the online marketplace ecosystem in China accounts for 90 percent of transactions, though covers only 70 percent of investment. The current level of online market activity breaks down on a GDP per capita basis.

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