Buying 10,810 cheap Tesco shares would give me dividend income of £1,200 this year

Tesco shares combine a healthy dividend yield with growth prospects. The business has done well in a competitive market so should I buy today?

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Tesco (LSE: TSCO) shares remain hugely popular. They consistently number among the top 10 most traded FTSE 100 stocks. Today, they look good value too, trading at just 11.7 times earnings and yielding 4.33%, covered twice by earnings.

The yield is forecast to hit 4.77% in the group’s 2025 financial year. By then, interest rates may be notablly lower, so this is likely to beat the returns from cash. 

A tempting income growth stock

There’s also the potential for capital growth on top, should the Tesco share price rise from here. But here’s the catch. Its shares haven’t done that well lately. They’ve fallen around 5%, measured over both one and five years.

Past performance figures are tricky things. Within that five-year range, Tesco shares have enjoyed bursts of outperformance. They did well during the pandemic, when the nation realised just how vital the big supermarkets are in keeping us fed and watered. They also recovered swiftly from last spring’s cost-of-living crisis.

I’m on the hunt for FTSE 100 stocks to generate a passive income, and I’m tempted by Tesco as I have no exposure to the grocery sector. In both 2022 and 2023 it paid a dividend per share of 10.9p. For 2024, 11.1p is forecast.

Now, let’s say I wanted to generate income of £100 a month from these shares, which adds up to £1,200 a year. To do that, I’d have to buy 10,810 of them. At today’s share price of around 250p, that would cost me a whopping £27,025.

That’s more than my entire Stocks and Shares ISA allowance for this year so I’d have to spread my purchase over a couple of tax years. But would I want to go so big on this one stock?

I’ll take a smaller stake

Tesco is still the dominant player in the grocery sector, with 27% of total market share, according to Kantar. That’s down from 30.7% in 2011, but I still think it’s a strong performance, given the inroads made by Aldi and Lidl. In a fiercely competitive sector, Tesco has shown it has staying power. Second-placed grocer Sainsbury’s only has a 14.9% share.

As well as income, Tesco could deliver share price growth as well. The 10 analysts offering 12-month price targets for the stock set a median 302p, according to the FT. That would see the shares rise 20% from here. Not bad (although not guaranteed either).

Now could be a good time to take a position but I wouldn’t expect an instant rebound as today’s rampant food inflation squeezes shoppers. The big supermarkets have been accused of profiteering. Yet Tesco’s margins are a wafer thin 2.3%. This is a huge operation with large staff numbers and a vast spread of bricks and mortar sites, with hefty tax bills to match. As an investor, that worries me. There must be easier ways to make money.

I wouldn’t invest £27k in Tesco today. My portfolio is too small for that. I’ll start by investing, say, £2k and see how it goes. Sadly, that will give me income closer to £100 a year, but I’ll look to build my position (and income) over time.

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 has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco Plc. 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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