Will Tesco plc become the best dividend stock in the FTSE 100?

Is Tesco plc (LON: TSCO) about to unleash stunning dividend growth?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

It may seem rather strange to discuss dividends and Tesco (LSE: TSCO) in the same sentence. After all, the company did not pay a dividend in its most recent financial year. However, it seems to have significant scope to not only reintroduce one this year, but to grow it at a rapid rate. Therefore in time, it could become one of the top dividend stocks in the FTSE 100.

Changing business

Tesco is making huge changes to its business model. While a few years ago it was focused on becoming a conglomerate with assets in a wide range of countries, today it is returning to its roots as a UK-focused grocer. This should equate to greater efficiency and a focus on improving the company’s competitive advantage. It should also allow more capital to flow into developing its core offering.

As well as improving its efficiency, the acquisitions and disposals programme put in place may lead to an improving balance sheet. The purchase of Booker could create synergies, while the sale of other assets is helping to reduce the company’s overall leverage. This may make higher dividends more likely in future, since lower debt may mean lower risk.

Growth potential

The changes being made by Tesco are due to result in significant earnings growth over the medium term. For example, in the current year it is expected to record a rise in its earnings of 40%, followed by additional growth of 30% next year. Not only could this act as a positive catalyst on the company’s share price, it may also lead to a rapidly-rising dividend.

In the current financial year, the company is due to reinstate a dividend so that it yields 1.8%. While unimpressive, it is forecast to raise dividends per share by 77% in the following year so that it yields 3.2%. However, even a 77% rise in dividends will leave Tesco with a forecast payout ratio of just 46%. This suggests that it could afford to pay out a higher proportion of profit as a dividend, which could mean dividend growth is higher than earnings growth over the medium term.

Competition

Of course, investors seeking a high yield today may wish to look elsewhere in the FTSE 100. One stock which offers a strong income outlook is diversified financial services business Old Mutual (LSE: OML). It currently yields 5.2% from a dividend which represents 46% of earnings. Therefore, there is also scope for the company to increase shareholder payouts at a faster pace than profit growth in future years.

In addition, Old Mutual is expected to grow its bottom line by 16% this year. This puts its shares on a price-to-earnings growth (PEG) ratio of 0.5, which mirrors that of Tesco. As such, both stocks seem to be worth buying at the present time. For more patient investors, Tesco could be the superior option, and in time it may become one of the FTSE 100’s very best income plays.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens owns shares of Old Mutual and Tesco. The Motley Fool UK has recommended Booker. 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.

More on Investing Articles

Investing Articles

Would Warren Buffett buy BP shares, as oil excitement grows?

Warren Buffett is a big investor in the oil business, and BP's performance has been attracting investor attention in results…

Read more »

Cropped shot of an affectionate young couple posing with a bunch of flowers in their kitchen on their anniversary
Investing Articles

Here’s how long-term loyalty to UK shares can lead to dazzling returns!

The most successful UK and US share investors buy shares to hold for the long term, as this report shows.

Read more »

Investing Articles

NatWest has just smashed brokers’ dividend forecasts!

After NatWest delivered a Valentine’s Day surprise to investors, our writer thinks the experts may have to raise their dividend…

Read more »

Investing Articles

The NatWest share price slips in early trading despite positive FY 2024 results. What’s the deal?

The NatWest share price is down slightly this morning after the bank released its final results for 2024. Our writer…

Read more »

Young Asian man drinking coffee at home and looking at his phone
Investing Articles

My Legal & General shares have climbed just 7% — so how come I’m sitting on a 20% gain?

Harvey Jones' trading account is showing only a modest return on his Legal & General Shares, but on drilling down…

Read more »

Investing Articles

Prediction: the BP share price could rise in 2025 (or it might fall!)

Following this week’s release of the energy giant’s 2024 results, our writer reviews the prospects for the BP (LSE:BP.) share…

Read more »

many happy international football fans watching tv
Investing Articles

What’s gone wrong with the FTSE 100’s ‘King of Trainers’?

Feeling the pain of a 28% drop in the JD Sports share price over the past three months, our writer…

Read more »

Investing Articles

Is it too late for investors to consider buying these outstanding FTSE 100 shares?

Stephen Wright wonders whether now's the time to consider buying shares in the FTSE 100’s outstanding companies, despite some high…

Read more »