Excerpt: Stephen Wright thinks the number 27 is crucial for anyone thinking of buying Tesco shares. In his view, it’s what sets the company above its peers.
If I’d invested £1,000 in Tesco (LSE:TSCO) shares five years ago, I’d have an investment worth £1,170 today. That’s slightly better than Sainsbury (£1,149) and Marks and Spencer (£1,140).
Shares in a supermarket can be a great defensive investment. But when it comes to working out which one to buy, there’s one number in particular that I think investors need to think about.
Inventory
On a retail company’s balance sheet, ‘inventory’ refers to the things the business has for sale. It shows up as an asset, but that can be misleading.
The point of a retail business isn’t to accumulate stock. It’s to get products sold to customers as quickly as possible and repeat.
Maintaining high inventory levels is expensive. The issue comes with storing it, whether that’s on shelves or in a warehouse.
When items sit on shelves, they take up space that could be allocated to items that would sell better. So there’s an opportunity cost to the retailer from the products they could have sold.
Storing inventory in a back room or a warehouse is arguably worse, though. Retailers have to pay for the space to keep their products, which adds to their overall costs.
The best retailers are therefore ones that can get things out of the door quickly and get the next lot of products in. This is where the sales-to-inventory ratio comes in.
Sales-to-inventory
The sales-to-inventory ratio is a way of measuring how effectively a company shifts its stock. It compares the firm’s revenues over a specific time with its average inventory during the period.
In the case of Tesco, for 2023 that calculation looks like this:
| Tesco | 2023 |
|---|---|
| Average inventory | £2,424,500 |
| Sales | £65,762,000 |
| Sales-to-inventory | 27.12 |
This implies that Tesco turns over its entire inventory 27 times during the last financial year. To see whether that’s a good performance or not, I think it’s best to look at some comparisons.
Here’s the same ratio for Tesco going back a couple of years. The number has picked up since 2022, indicating some strong improvements on this front.
| Tesco | 2023 | 2022 | 2021 |
|---|---|---|---|
| Average inventory | £2,424,500 | £2,204,000 | £2,251,000 |
| Sales | £65,762,000 | £61,383,000 | £45,778,000 |
| Sales-to-inventory | 27.12 | 27.85 | 20.33 |
It’s also worth comparing the company’s sales-to-inventory ratio with some of its peers. So here are the same metrics for Sainsbury and M&S.
| Sainsbury | 2023 | 2022 | 2021 |
|---|---|---|---|
| Average inventory | £1,848,000 | £1,711.00 | £1,678.50 |
| Sales | £31,491,000 | £29,895.00 | £29,048.00 |
| Sales-to-inventory | 17.04 | 17.47 | 17.31 |
| Marks & Spencer | 2023 | 2022 | 2021 |
|---|---|---|---|
| Average inventory | £735,000 | £665,500 | £594,500 |
| Sales | £11,931,000 | £10,885,000 | £9,156,000 |
| Sales-to-inventory | 16.23 | 16.36 | 15.40 |
What this shows is that Tesco consistently fares better than its peers in terms of keeping products moving off its shelves. And that’s a very positive sign for investors.
Is Tesco the best?
The sales-to-inventory ratio doesn’t, by itself, show that Tesco shares are a better investment than any other supermarket. It isn’t a magic formula that means investors can ignore everything else.
In my view, though, it does illustrate something important about the business. That’s why I think anyone considering buying the stock ought to think carefully about that number and what it means.
This post was originally published on Motley Fool
