I’m looking to generate a regular monthly income by building a portfolio of FTSE 100 stocks and Tesco (LSE: TSCO) shares have caught my eye.
The UK’s biggest supermarket chain current yields 4% a year, comfortably above the average of 3.5% for the lead index as a whole. Better still, this is covered twice by earnings, and management has a good recent track record of increasing shareholder payouts.
That’s a decent yield
In 2019, Tesco’s dividend per share was 5.77p, which jumped to 9.15p in both 2020 and 2021, then 10.9p in 2022. However, there was a slight setback this morning, as management announced it will freeze the dividend at 10.9p in 2023.
That’s disappointing but hardly surprising, as the grocery industry has been on the front line of the cost-of-living crisis as food prices rocket.
Today’s interim results showed pre-tax profits halving in the 2022/23 financial year, to £1bn. That’s despite a 7.3% rise in group sales to £56.7bn. Its traditional wafer-thin margins were sliced again, falling 57 basis points to 3.8%.
Unsurprisingly, chief executive Ken Murphy said the big challenge is “unprecedented levels of inflation in the prices we have paid our suppliers for their products, and the cost of running our own operations.”
Despite this, Tesco’s market position is strong, as fights back against Aldi and Lidl. It’s the only one of the traditional full-line grocers to gain share over three years.
The forecast yield is 4%, same as today, covered twice by earnings. The payout looks reliable, as Tesco generated £2.13bn of retail free cash flow. That was a drop of £144m on last year, but was enough to fund a £750m share buyback as well. Shareholder returns totalled more than £1.6bn. I’d like my share of that.
Sadly, I can’t afford to buy enough Tesco shares to generate my target income of £100 a month from this stock alone. To achieve that, I’d need to buy 11,009 shares.
I’ll invest a smaller sum
Right now, Tesco shares cost around 266p, having clicked up 0.5% this morning. So to hit my target, I would need to spend £29,283 on them.
Sadly, I don’t have that kind of money to hand. And even if I did, I wouldn’t put so much into one stock. Plus, I’d bust through my £20,000 ISA allowance.
I could hit my income target with a smaller stake, by investing in a higher yielding FTSE 100 stock. Asset manager M&G currently yields 10% a year. I could secure £100 a month income by investing just £12,000 in that.
However, I already hold M&G. I would like to balance it by purchasing Tesco, which I think could do well as the inflationary squeeze eases.
There are risks, as ever. It operates in a tough sector, and if inflation stays higher for longer than expected, management may struggle to drive up that dividend.
Yet today’s valuation of 12.2 times earnings compensates for that, in my view.
Tesco’s final dividend of 7.05p per share will be paid on 23 June to shareholders registered by 12 May. I plan to buy this stock before then, although I’ll invest closer to £2,000 than £29,283.
