Is it time to buy Tesco?

I’ve made the argument for Tesco as my favoured supermarket play over recent months. More than that, I believe it could be an internet giant. I guess it’s the contrarian in me. Give me a sector and a stock in the doghouse, and there’s a good chance I’ll be running the slide rule over the business.

But it’s more than just being contrarian. It strikes me that Tesco is the only supermarket major with a vision for what they term “multi-channel” retailing. I’ve already made my thoughts clear on Morrisons’ divisive price attack on the industry. Financing a price war by mortgaging your property estate looks like a bit of a gamble to me.

So, I like Tesco. A couple of months back, I showed you a simple tool that I use all the time to help locate a sensible in-price. And that is the Bollinger band. Today, I’m going to see what Bolly bands tell us about Tesco shares.

If you’re considering a position in Tesco, then you’ll want to get your timing right. After all, contrarian plays are rarely slam-dunks.

What Bolly bands tell us about Tesco

The Bollinger band is a simple chart overlay (available on most online charting packages) that plots out a stock’s trading range.

The essential advice is, don’t buy a stock at the top of its band. We looked at IG index at the time. A great business, going great guns. But the last thing I wanted you to do was to chase the stock higher.

IG was trading at about £6.30, and the chart suggested to me that it should drop to around £6.20 (about a third off the top of the Bolly band). And that turned out to be true. There were at least two opportunities to buy sub-£6.20 over the last couple of months. That’s a decent discount, and certainly worth having.

Right. But in the case of Tesco, there’s no talk of chasing the stock higher. On the contrary, as the following chart shows, this one is trading near the bottom of its Bollinger range, certainly not the top.

So the question is, can we still use our Bolly bands to help with our timing?

Tesco share price chart with Bollinger bands

The blue Bolly range shows us where a share price ‘should’ trade (statistically speaking) with 95% accuracy. In that sense, it’s better to buy when the stock is nearer the bottom of its range.

While it’s a great way of getting your short-term timing right, it’s certainly not a fool proof strategy for long-term investment. This chart shows that.

Despite hitting the bottom of the band many times, it continued to trace lower, and lower… and lower. As the share drops, it just drags the Bollinger band down with it.

Pick your ‘bottom-fishing’ strategy

The band is nonetheless useful for bottom-fishing these types of turnaround plays. At first sight, there’s certainly a lot of overhead blue sky on the chart. If the price returns towards the top of its band (which is not uncommon), then there could be an easy 10% profit in store.

However, given the sentiment surrounding the industry, we probably shouldn’t get too excited about a quick rebound. What’s more likely to happen is that Tesco will settle in its new range. As the price remains at this level, so it will establish a tighter and lower Bollinger band. And as it does, we can use the band as a guide to a decent entry point.

Attacking the ‘bottom-fishing’ problem this way will hopefully keep us from making a mistake. If the price continues to chase lower, then at least we’re not losing money. We’re not sucked in before another precipitous fall.

Playing the waiting game is the safest strategy – but it may mean you miss the absolute price low. That’s why less risk-averse investors will just pile in anyway. With a well-covered dividend prop, there’s no doubt in my mind that anything sub-three quid is good value.

Then again, there’s no doubt, I’ve got myself wet on these bottom-fishing expeditions in the past. The safe play is to wait and let the stock establish a new range. Then buy when the price hits the bottom. The more carefree approach says “Just buy”, it’s cheap!

Horses for courses, as they say. Whatever way investors choose to play it, it’ll be interesting to see how the band develops.