At £2.57, is now the time for me to buy shares in this major FTSE retailer after a 15% drop?

Shares in FTSE 100 supermarket J Sainsbury (LSE: SBRY) have fallen 15% from their 10 September 12-month traded high of £3.01.

A sizeable drop for such a leading firm signals to me that a major bargain might be had. Alternatively, it might indicate that the company is essentially worth less than it was previously. I took a closer look at its performance numbers and share price valuation measures to ascertain which it is.

Why is the stock down?

I think the primary driver for the share price tumble is the potential impact of the October Budget on the retail sector.

The 1.2% increase in employers’ National Insurance threatens a massive increase in costs for big firms like Sainsbury’s. The resulting business decision is to pass these on to customers or to cut costs, or some combination of both.

Indeed, 23 January saw it announce 3,000 jobs would be cut and that all its remaining in-store cafes would close.

The main risk for Sainsbury’s is the continued effect of this tax rise – and any further rises — in my view.

How does the core business look?

Longer term, a firm’s share price (and dividend) is ultimately driven by its earnings growth. In Sainsbury’s case, analysts forecast that these will increase by a stellar 20.26% each year to the end of 2027.

This looks well-supported by its 7 November H1 2024-2025 results showing retail sales up 3.1% year on year, to £16.3bn. Underlying operating profit rose 3.7% to £503m.

Its key Christmas quarter running to 4 January saw a 2.8% rise in underlying sales. It added in the results announcement that it expects full-year underlying operating profit in line with consensus. This is in the midpoint of its £1.01bn-£1.06bn guidance range.

Are the shares undervalued?

My starting point in ascertaining whether a stock is underpriced is to compare its key valuations with its competitors.

On the price-to-earnings ratio, Sainsbury’s is currently at 33.3 against a peer average of 13.2. These comprise Carrefour at 10.5, Tesco at 12.7, Marks and Spencer at 12.9, and Koninklijke Ahold Delhaize at 16.8.

So, Sainsbury’s looks overvalued on this measure.

However, on the price-to-sales ratio, it looks slightly undervalued — at 0.2 compared to a 0.3 competitor average. And it looks even more undervalued on price-to-sales ratio – at 0.9 against a 1.8 average for its peers.

To bring some further clarity to the matter, I ran a discounted cash flow analysis. This assesses where a stock should be, based on future cash flow forecasts. It shows Sainsbury’s shares are 57% undervalued at their current £2.57 price.

Therefore, their fair value is technically £5.98, although market unpredictability may push them lower or higher.

However, it does underline to me that the stock looks a potential bargain right now.

Will I buy the shares?

I focus on dividend stocks that yield over 7%. Aged over 50 now I am to increasingly live off this income while reducing my working commitments. Sainsbury’s yield is currently 5.1%, so it is not for me on this basis.

However, if I was even 10 years younger it would be on my watchlist as a potential growth stock buy. It projected strong earnings growth should power its share price and dividend much higher over time, I think.

The post At £2.57, is now the time for me to buy shares in this major FTSE retailer after a 15% drop? appeared first on The Motley Fool UK.

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Simon Watkins has no position in any of the shares mentioned. The Motley Fool UK has recommended J Sainsbury Plc and Tesco Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.