Sector Screener: time to grab Tesco and Sainsbury’s shares?

Consumer-focused stocks have experienced a challenging period over recent years. Consistent above-target inflation and tight monetary policy have put disposable incomes under sustained pressure. This has resulted in increasingly price conscious behaviour that has weighed on company profit margins and even led to lower demand as consumers have switched to cheaper substitutes or reduced their consumption of a wide range of goods.

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An evolving outlook

In the short run, it would be unsurprising if this trend continued. After all, inflation in the UK is still 160 basis points above the Bank of England’s 2% target, while interest rates stand at 4%. By recent historical standards, both readings are relatively high. Indeed, inflation has averaged 2.8% over the past 20 years and interest rates were below 1% between the global financial crisis in 2009 and the current era of tight monetary policy that began in 2022.

In the long run, though, consumer-focused stocks are set to be catalysed by an improving industry outlook. The Bank of England expects inflation to fall to its 2% target during the first half of 2027. This should allow further interest rate cuts to be implemented both prior to that event and in the long run, with an unemployment rate recently hitting a 52-month high of 5% and lacklustre GDP growth signalling that a brisk pace of monetary policy easing is even more likely.

Sector potential

Falling interest rates, as well as lower inflation, should help ease cost-of-living pressures among consumers. Improved spending power may, in time, provide scope for price rises, higher margins and, ultimately, greater profitability among consumer-focused firms such as those operating in the FTSE 350 Personal Care, Drug & Grocery Stores sector.

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It has severely lagged the wider stock market over the past five years, rising by just 13% versus a 42% increase for the FTSE 350 index. Although it contains several global consumer-focused companies such as Reckitt and Unilever, its members also include UK-focused grocers such as Tesco and Sainsbury’s. The former have previously been discussed in this column, with the latter also being well placed to capitalise on an improving consumer outlook.

Source ShareScope. Data at 10 December 2025. Past performance is not a guide to future performance.

Source ShareScope. Data at 10 December 2025. Past performance is not a guide to future performance.

A changing grocery market

Indeed, grocery shopping behaviour in the UK is likely to change as interest rates and inflation both fall. This should lead to reduced price consciousness among consumers, with them likely to become less interested in the cost of specific items and more focused on other factors including convenience, customer service and product quality.

In response, UK-focused grocers are likely to shift their emphasis away from the price competition that has been a key feature of the market over recent months. In future, they may focus to a greater extent on non-price factors when seeking to differentiate their offering. Over time, this change in industry dynamics may provide scope for reduced investment in pricing and, in the long run, higher profit margins that leads to growing bottom lines and rising share prices among UK grocers.

Risk/reward ratio

Clearly, that process is still in its relative infancy. Although inflation is expected to decline as per the Bank of England’s forecasts over the next 18 months, it may prove to be stickier than anticipated. This may limit the central bank’s capacity to cut borrowing costs, thereby potentially leading to continued cost-of-living challenges, raised price consciousness among consumers and further investment in pricing among UK-focused grocers.

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In the long run, though, companies such as Tesco (LSE:TSCO) and Sainsbury (J) (LSE:SBRY) appear to offer investment appeal. Their relatively attractive market valuations, sound fundamentals and the prospect of an improved operating environment amid an increasingly upbeat consumer outlook mean there could be favourable risk/reward opportunities on offer.

Source ShareScope. Data at 10 December 2025. Past performance is not a guide to future performance. *Reflects a one-off special dividend of 11p following the sale of the company’s banking operations to NatWest

Solid fundamentals

For example, Sainsbury’s shares currently trade on an earnings multiple of almost 14 even after their 16% rise over the past year. This suggests they offer good value for money given that the FTSE 100 index, of which the company is a member, has a price/earnings (PE) ratio of 17.4.

Furthermore, the retailer upgraded its financial guidance for the current year at the time of its half-year results last month. It now expects to generate retail underlying operating profit of more than £1 billion versus previous guidance of around £1 billion. Although its earnings per share (EPS) is only expected to rise by 1% this year, its growth rate is forecast to accelerate to 14% next year amid a potentially improved operating environment.

In the meantime, the company appears to have the financial strength to overcome further challenges for consumers. Its net debt-to-equity ratio, for example, stood at 82% at the time of its half-year results in September. Meanwhile, net finance costs were amply covered 3.3 times by operating profits in the first half of the current year.

Potential volatility

Alongside its capital growth potential, Sainsbury’s continues to offer an attractive income return outlook despite its share price rise. Its shares currently yield 4.3% (although the table above shows 6.6%, which reflects a one-off special dividend of 11p following the sale of the company’s banking operations to NatWest), which is 110 basis points higher than the FTSE 100 index’s income return, with dividends per share being covered 1.7 times by earnings last year. This suggests that dividend growth could prove to be brisk and above inflation, especially when the company’s upbeat profit growth prospects are taken into account.

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Clearly, the retailer’s share price could prove to be volatile. News of a sale of shares in the company by Qatar’s sovereign wealth fund earlier this month, with its stake in the firm set to fall from 10.5% to around 7%, has contributed to a 4% drop in the company’s share price since the announcement. While further declines cannot be ruled out in the short run, Sainsbury’s appears to offer a favourable long-term outlook based on its relatively attractive valuation, upbeat income prospects and solid financial position.

A strong competitive position

Similarly, Tesco could offer long-term investment potential. The company’s investment in pricing over recent months contributed to an increase in market share during the first half of the year. It now stands at 28.4% of the UK grocery market, which suggests it is well placed to benefit from a potential upturn in industry dynamics. Indeed, the company’s EPS is forecast to rise by around 11% next year amid a prospective decline in inflation and continued monetary policy easing.

A solid balance sheet means the firm is in a strong position to overcome potential economic challenges in the short run. Its net interest cover in the first half of the year, for example, amounted to 5.4. A sound financial position also means the firm can afford to engage in share repurchases, with it recently announcing the continuation of a £1.45 billion buyback programme that should provide support to its share price.

A premium valuation

Of course, a 21% share price rise over the past year means that Tesco now trades on a rather lofty market valuation. Its PE ratio, for example, is 16.1. A rising share price has also squeezed its dividend yield, which at 3.2% is the same as the FTSE 100 index and is less attractive than the income returns of other consumer-focused firms.

However, fast-paced earnings growth prospects, a strong market position and sound fundamentals suggest the stock is worthy of its premium valuation. Dividend cover of two last year also indicates that shareholder payouts could rise at a relatively brisk pace in future. Therefore, given the potential for an improving consumer outlook over the long run, Tesco’s shares appear to offer a favourable risk/reward opportunity at present.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.