Under £5 now! Here’s why I think Tesco’s share price should be trading closer to £7

There is a big gap between Tesco’s (LSE: TSCO) share price and the underlying business’s true value, in my view.

The market still prices the UK’s dominant grocer as if it were a low‑growth plodder rather than the disciplined, cash‑generating operator it has become. Yet its margin control, scale advantages and dependable earnings profile tell a far more compelling story.

So where should the stock really be trading now, based on its true worth? 

Key drivers for growth

The engine for share price gains in any stock is earnings growth momentum.

A risk for Tesco is the high degree of competition in the sector that may narrow its margins. Another is any further surge in the cost of living that may cause customers to reduce spending. Even so, analysts forecast its earnings will increase by an average of 9.2% a year to end-2028 at minimum.

This looks well supported by its previous fiscal-year 2024/25 results.  Adjusted operating profit jumped 10.9% year on year to £3.13bn, reflecting strong volume performance, Save to Invest delivery and improved category mix in Central Europe.

Adjusted earnings per share soared 17% to 27.38p, helped by higher profit, lower finance costs and ongoing buybacks. Since October 2021, Tesco has bought back and retired £2.8bn of shares. An ongoing buyback totalling £1.45bn will complete by the end of this month.

In its latest results (Q3, released on 8 January), management said it expects 2025/26 full-year adjusted operating profit at the upper end of previous guidance. This was in the range of £2.9bn-£3.1bn.

Where ‘should’ it be priced?

Discounted cash flow (DCF) analysis pinpoints the ‘fair value’ at which any share should trade by projecting the underlying business’s future cash flows and ‘discounting’ them back to today.

This fair value is often very different from the share’s market price at any given moment. And the difference between the two can provide a huge opportunity for long-term investors to make big profits. The reason is that share prices tend to trade to their fair value over the long run.

Analysts’ DCF results can vary, based on the inputs used — some more bearish. But my modelling (including an 8.1% discount rate) shows Tesco shares are 29% undervalued at their present £4.79 price.

Therefore, their fair value is around £6.75 — significantly higher than where they trade today.

So, given the tendency for price and value to converge over time, this could be a superb buying opportunity to consider today if those DCF assumptions hold.

My investment view

Tesco’s core appeal lies in the strength and reliability of the cash the business generates, in my view. Steady cash flows fund regular buybacks, support a stronger balance sheet and give it the firepower to protect margins and market share.

Those qualities help underpin long‑term profit growth and reduce the risk of earnings shocks, rising debt pressure or competitive erosion.

Given the stock’s significant discount to fair value, I think it well worth the attention of long-term investors.

In my case, I already hold shares in Marks and Spencer, so another in the sector would unbalance my portfolio. However, other deeply-discounted high-growth stocks have caught my eye in recent days.