How much passive income could I earn if I buy Tesco shares today?

Buying Tesco shares has rewarded investors with solid dividends for decades, and the foreacast shows more years of growth ahead.

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Image source: Tesco plc

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Tesco (LSE: TSCO) shares have a long track record of paying reliable dividends, with only a few blips.

Is it an ideal stock to tuck away in my retirement portfolio? I think it just might be.

Tesco might not offer the market’s biggest dividend yield. But a forecast 4.2% could build up nicely over the years, especially if it grows each year.

But, first, what actually are dividends?

Spread the cash

Essentially, they come from a company’s earnings, after all its outgoings. So whatever the firm doesn’t need for reinvestment, working capital, a safety cash buffer, etc., is often divided among shareholders.

Well, that’s in an ideal case, at least.

Some companies priortise dividends. And they pay them even if they don’t have the earnings to cover them. It might come out of cash reserves, and that can be fine.

Earnings can vary from year to year, and dividends can be evened out by retaining cash in better years to cover the weaker years.

Investment trusts

That’s something investment trusts do, by the way. And it’s why some of them have been able to lift their dividends for more than 50 years in a row. But that’s a story for another day.

Some firms, though, keep paying dividends in excess of earnings for years. They might also build up large amounts of debt. So, yes, they’re effectively borrowing money to hand out to shareholders.

But as long as they can balance the books, shareholders can be happy to take the cash. Something has to give, though.

Just look at where the BT Group and Vodafone share prices have gone in the past 10 years, while dividends have gone uncovered. Hint: it’s not up.

Back to Tesco

The Tesco dividend is around twice covered by earnings. And forecasters expect it to stay that way.

Oh, and they predict rising dividends, to reach close to 5% by 2026.

So, finally to my question, how much annual income might we build up from Tesco shares? Different investors have different amounts at different times, so here’s a few options.

ISA allowance

A single ISA allowance of £20,000 invested in Tesco shares and left for 20 years could grow to over £45,000, which could then pay out close to £2,000 per year.

Or, £5,000 invested per year in Tesco (at a bit over £400 per month) for 20 years could grow to £155,000, and pay £6,500 per year.

Or a fairly modest £200 per month could still grow to nearly £75,000 in that time, then yield £3,100 each year.

Managing risk

Now, all shares carry risk. Tesco faces competition from the super cheapies like Aldi and Lidl, which are nibbling at its market share.

Tesco has got a few things badly wrong in the past too, expanding where it wasn’t really able to pull it off. And competitive pressures can surely only grow.

But I do think we can build up some nice retirement income by buying stocks like this, that share the kind of cash flow and earnings cover that Tesco can boast.

And I reckon I could come up with a diversified selection averaging even more than Tesco’s 4.2%.

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.

Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco Plc and Vodafone Group Public. 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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