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Buffett Cuts His Tesco PLC Stake: Should You Sell?

A London Stock Exchange filing yesterday revealed that Warren Buffett sold 20% of his stake in Tesco (LSE: TSCO) (NASDAQOTH: TSCDY.US) earlier this month, reducing his interest in the firm from 4.98% to 3.98%.

Buffett has been a high-profile admirer of Tesco since 2006, when he built up his initial 2.9% stake in the firm. He then made further purchases in 2010 and in 2012, following the firm’s infamous profit warning, which triggered a 20% drop in Tesco’s share price.

The question for Tesco investors like us is whether Buffett has decided that Tesco’s long-term prospects are no longer appealing, or whether there is a more innocent reason for his sale.

Has Buffett made a profit?

One key question is whether Buffett’s firm Berkshire Hathaway has made a profit on its Tesco holding.

It’s hard to know exactly how much Buffett paid for his Tesco share purchases, but from looking at the timing of his purchases, my back-of-the-envelope estimate suggests his holding may have risen in value by between 10% and 20% above his average purchase price.

In addition, Buffett has received substantial dividend payments — by my calculations, his dividend income in 2012 alone may have been almost £60m!

Why is Buffett selling?

Buffett’s decision to sell around £300m of Tesco shares came shortly after the firm’s recent interim results were published, showing that Tesco’s pre-tax profit fell by 23.5% during the first half of this year.

It’s reasonable to suggest that Buffett has become concerned about Tesco’s turnaround progress, but I think there could be another, more harmless, explanation.

Following Tesco’s recent exit from its US Fresh & Easy business, the company is no longer active in the US market. Buffett is famously keen on investing in domestic companies whose businesses he understands, so he may simply be trimming his exposure to overseas investments, which carry increased currency and market risks for US investors.

Should you sell?

As a Tesco shareholder myself, I have no intention of selling. Although I think Tesco’s turnaround could be a little tougher than expected, I still think that the firm is an attractive long-term income investment.

Tesco’s expected return to profit this year has helped drive a 10% increase in its share price, and the firm’s half-year results were broadly in-line with expectations, suggesting that the firm may be able to return to dividend growth in 2014.

Today's top income buy?

Tesco remains an attractive income share, with a long history of dividend growth and an attractive 4% yield.

However, the Motley Fool's analysts have scoured the FTSE 100 and identified a company they believe may be a better choice. The company in question offers a prospective yield of 5.5% and the Fool's analysts believe it could currently be undervalued by as much as 10%.

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> Roland owns shares in Tesco but does not own shares in any of the other companies mentioned in this article. The Motley Fool owns shares in Tesco.