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Today we'll take a closer look at Tesco PLC (LON:TSCO) from a dividend investor's perspective. Owning a strong business and reinvesting the dividends is widely seen as an attractive way of growing your wealth. If you are hoping to live on the income from dividends, it's important to be a lot more stringent with your investments than the average punter.
A slim 2.5% yield is hard to get excited about, but the long payment history is respectable. At the right price, or with strong growth opportunities, Tesco could have potential. The company also bought back stock equivalent to around 0.7% of market capitalisation this year. Some simple analysis can reduce the risk of holding Tesco for its dividend, and we'll focus on the most important aspects below.
Companies (usually) pay dividends out of their earnings. If a company is paying more than it earns, the dividend might have to be cut. As a result, we should always investigate whether a company can afford its dividend, measured as a percentage of a company's net income after tax. Tesco paid out 42% of its profit as dividends, over the trailing twelve month period. This is medium payout level that leaves enough capital in the business to fund opportunities that might arise, while also rewarding shareholders. One of the risks is that management reinvests the retained capital poorly instead of paying a higher dividend.
In addition to comparing dividends against profits, we should inspect whether the company generated enough cash to pay its dividend. Tesco paid out 53% of its cash flow as dividends last year, which is within a reasonable range for the average corporation. It's positive to see that Tesco's dividend is covered by both profits and cash flow, since this is generally a sign that the dividend is sustainable, and a lower payout ratio usually suggests a greater margin of safety before the dividend gets cut.
We update our data on Tesco every 24 hours, so you can always get our latest analysis of its financial health, here.
Before buying a stock for its income, we want to see if the dividends have been stable in the past, and if the company has a track record of maintaining its dividend. Tesco has been paying dividends for a long time, but for the purpose of this analysis, we only examine the past 10 years of payments. The dividend has been cut by more than 20% on at least one occasion historically. During the past ten-year period, the first annual payment was UK£0.11 in 2009, compared to UK£0.058 last year. The dividend has shrunk at around 6.5% a year during that period. Tesco's dividend hasn't shrunk linearly at 6.5% per annum, but the CAGR is a useful estimate of the historical rate of change.
We struggle to make a case for buying Tesco for its dividend, given that payments have shrunk over the past ten years.
Dividend Growth Potential
Given that dividend payments have been shrinking like a glacier in a warming world, we need to check if there are some bright spots on the horizon. It's not great to see that Tesco's have fallen at approximately 10% over the past five years. Declining earnings per share over a number of years is not a great sign for the dividend investor. Without some improvement, this does not bode well for the long term value of a company's dividend.
When we look at a dividend stock, we need to form a judgement on whether the dividend will grow, if the company is able to maintain it in a wide range of economic circumstances, and if the dividend payout is sustainable. Tesco's dividend payout ratios are within normal bounds, although we note its cash flow is not as strong as the income statement would suggest. Second, earnings per share have been in decline, and its dividend has been cut at least once in the past. While we're not hugely bearish on it, overall we think there are potentially better dividend stocks than Tesco out there.
Without at least some growth in earnings per share over time, the dividend will eventually come under pressure either from costs or inflation. See if the 17 analysts are forecasting a turnaround in our free collection of analyst estimates here.
Looking for more high-yielding dividend ideas? Try our curated list of dividend stocks with a yield above 3%.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.