Can Tesco Outperform Wal-Mart Stores?

LONDON -- If you're interested in building a profitable, diversified portfolio, then you will often need to compare similar companies when choosing which share to buy next. These comparisons aren't always as easy as they sound, so in this series I compare some of the best-known names from the FTSE 100, the FTSE 250, and the U.S. stock market.

I use three key criteria -- value, income, and growth -- to compare companies to their sector peers. I've included some U.S. shares, as these provide U.K. investors with access to some of the world's largest and most successful companies. Although there are some tax implications to holding U.S. shares in a U.K. dealing account, they are pretty straightforward, and I feel they are outweighed by the investing potential of the American market.

Today I'll take a look at supermarket giants Tesco and Wal-Mart Stores , which owns the Asda supermarket chain in the UK.

1. Value
The easiest way to lose money on shares is to pay too much for them. So which share looks like a better value?

Tesco edges ahead of Wal-Mart in terms of value, offering a lower P/E on both a historic and forecast basis. Tesco also trades on a much lower P/B ratio than Wal-Mart, although the two supermarkets' P/S ratios are evenly matched thanks to their near-identical profit margins. The P/S ratio can be useful for comparing the profitability of different companies within the same sector.

2. Income
With low interest rates set to continue for the foreseeable future, dividends have become one of the most popular ways of generating an investment income. How do Tesco and Wal-Mart compare in terms of income?

Tesco's dividend yield is 50% higher than that of Wal-Mart. U.S. dividend yields tend to be lower than comparable U.K. yields, and although Wal-Mart's dividend has grown at a faster rate than Tesco's over the last five years, the firm's payout ratio -- the proportion of its earnings paid as dividends -- remains lower than that of Tesco.

For me, Tesco is a clear winner in the income stakes, but although both companies have an outstanding record of continuous dividend growth -- 28 years for Tesco and 39 years for Wal-Mart -- it's worth noting that Tesco's dividends have not been covered by free cash flow since 2010, unlike those of Wal-Mart. Free-cash-flow cover is a good measure of dividend safety: Using reserves or borrowed money to pay shareholder dividends is not sustainable in the long term.

3. Growth
Even if your main interest is value or income investing, you do need to consider growth. At the very least, a company needs to deliver growth in line with inflation -- and realistically, most successful companies need to grow ahead of inflation if they are to protect their market share and profit margins.

How do Tesco and Wal-Mart shape up in terms of growth?

In terms of shareholder returns, Wal-Mart has hugely outperformed Tesco over the last five years. The U.S. firm's share price has risen by 45% during a period when Tesco's share price has languished and delivered almost zero returns. Yet underlying this, both companies have grown their earnings per share at a similar rate, and Tesco's revenue growth has moved ahead of that of Wal-Mart. What's more, over a 10-year timeframe, Tesco's shares price has risen by 120%, outperforming Wal-Mart's more modest 47% 10-year gain.

Should you buy Tesco or Wal-Mart?
Tesco is in the middle of a much-publicized effort to turnaround its fortunes. Apart from improving its existing stores, one aspect of this is cutting expenditure on very large new stores. Over time, an improved focus on profitability and smaller stores should help to improve its cash flow situation and support its dividend. Although Wal-Mart's finances appear to be more robust at present, I think Tesco's greater yield is worth the risk for U.K. investors, especially given its low P/E ratio, which makes the company look better value than Wal-Mart in my view.

In terms of growth, Tesco's stronger revenue growth rate appeals to me, because over time it should facilitate stronger earnings growth than Wal-Mart, assuming other factors -- such as profit margins -- remain roughly equal.

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The article Can Tesco Outperform Wal-Mart Stores? originally appeared on Fool.com.

Roland Head owns shares in Tesco. The Motley Fool owns shares of Tesco. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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