No company can make above-average profits for ever - just look at Sainsbury, says Andrew Loudon. So how long can Asda remain the best investment prospect?
To the casual reader of the financial pages, J Sainsbury must seem to be on its last legs. For the past few years, investors have had nothing but dark words for the supermarket chain. Profit warnings, management crises and calls for the head of its chairman, David Sainsbury, have created the impression that 'everybody's favourite ingredient' is past its sell-by date.
Nothing could be further from the truth. True, Sainsbury has been doing less well than its rivals. Arch-enemy Tesco has overtaken it in terms of both market share and stock-market value. But Sainsbury remains one of the most successful and profitable retailers in the country.
The graph supports that view. It shows the share price performance of Sainsbury, Tesco and Asda, relative to the stock market, over the past 20 years. The most striking fact is that, since 1977, Sainsbury and Tesco have delivered almost identical returns to their shareholders. The graph is also a classic illustration of the often forgotten investment adage that, over time, everything reverts to the mean, that is, without large barriers to entry, no company can make above-average levels of profit for ever.
Which is precisely what happened to Sainsbury. Under Lord Sainsbury, the group built a seemingly unassailable market position, pioneering concepts like own-brand products and out-of-town superstores. Eventually, however, planning permissions for superstores dried up, Tesco lined its shelves with Sainsbury quality own label, and Sainsbury's lofty stock-market rating became a sitting duck.
Wielding the shotgun was Tesco's Ian (now Lord) MacLaurin. From the moment he convinced his board to stop luring shoppers with Green Shield stamps, his aim was to move away from its founding pile-it-high, sell-it-cheap approach and pinch Sainsbury's clothes.
Sainsbury had nowhere to go. Yes, it made mistakes. It dabbled with price competition; it got distracted by acquisitions in the US; and having thumbed its nose at Tesco's loyalty card it was finally forced to introduce its own. But given the gulf that existed between Sainsbury and its rivals in the early '80s, it's hard to see how the company could have prevented it from narrowing.
All this shows that it's much easier for a poorly-performing company to become better, than for an exceptional one to stay miles ahead. For an example, look no further than Asda. On a 20-year view, it looks a sorry also-ran. But over the past five years, Asda has been by far the best investment of the three. Archie Norman's feat of turning a poorly-managed, debt-laden basket case into a fit competitor has produced a 450% gain for shareholders, against Tesco's 100% and Sainsbury's minus 7%. Now Asda faces the challenge of what to do next.
One thing is certain: like Sainsbury, it will not outperform for ever. The art of investment is deciding for how long it can.