I’d buy Tesco shares in October to bag their 5.4% yield 

Tesco shares have fallen lately but I think this makes them attractively valued for a dividend stock I would aim to hold for decades

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Tesco (LSE: TSCO) shares have had a bumpy 2022 but now they look like a tempting buy to me. The figure that really jumps out at me is the dividend yield, which is currently 5.4%.

Last time I looked, Tesco was yielding closer to 4%. The most obvious reason for the increase is that its share price has fallen (as have so many other FTSE 100 stocks in these troubled times).

Tesco shares are down 26% over the last six months, although over five years they trade 7.56% higher. As the yield is calculated by dividing the dividend by the share price, that has inevitably pushed it higher. Yet the dividend looks solid, as it is covered exactly twice by earnings.

Tesco shares are at a discount

This year has been tough on the grocery sector. Sainsbury’s has fared even worse. Its share price is down 31% in 12 months, and 30% measured over five years. That makes Tesco look relatively good, and of course it is.

Tesco is still the UK’s biggest grocer, with a market share of 26.9%, according to Kantar. That easily beats second-placed Sainsbury’s at 14.6% and Asda at 14.1%. The cost-of-living crisis has been tough on the big guns, while discounters Aldi and Lidl have continued their inexorable climb.

Earlier this month, Credit Suisse warned there was “no relief in sight” for grocers. They have little scope to pass on inflationary costs to customers, as those on low incomes either trade down or load up in Aldi.

Tesco is better placed than Sainsbury’s, but Credit Suisse still trimmed its target price from 292p to 238p. Today it trades at 173p. So why would I buy it today?

I’m not particularly optimistic about the UK economy. It’s going to be a tough winter. Chancellor Kwasi Kwarteng’s mini-Budget U-turn may have only given us temporary respite. Shoppers don’t have money to throw around.

Tesco’s management has indicated that its earnings may have further to fall, but I think much of the bad news is reflected in today’s valuation. The share price drop has also made Tesco cheaper to pop into my portfolio. It currently trades at just 9.2 times earnings, compared to roughly 14 times across the FTSE 100 as a whole.

I’d invest those dividends for growth

Tesco shares could get even cheaper if I waited, but that’s far from guaranteed. All I know is that they look good value right here, right now.

Also, Tesco gives me a high level of income. I couldn’t beat that 5.4% yield by putting the same money into a savings account at the moment. The sooner I buy the stock, the sooner those dividends start rolling into my portfolio. I would then reinvest them to buy more Tesco shares, taking advantage of today’s low valuation.

Tesco’s sheer size makes it look like a solid bet for long-term income and growth. I’d aim to hold it for 10 or 20 years. At some point, I hope its share price will rebound, and take my stock and reinvested dividends with it. This week, I’m fulfilling a promise I made at the end of last month to buy shares in Persimmon. When I have the cash, I’ll then look to buy Tesco.

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.

Harvey Jones doesn't hold any of the shares mentioned in this article. The Motley Fool UK has recommended Sainsbury (J) and Tesco. 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.

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