I’ve been wrong about Tesco (LSE: TSCO) for a while because the share price has gone up a lot — without me.
But one of my self-imposed rules is to shun the stock unless the dividend is yielding at least 5%. I want that amount of income to compensate me for the risk of holding the shares.
However, I wasn’t expecting to miss out on such a big rise in the stock price! But the shares have been flying in 2024. At around 374p, they’re up by almost 28% this year alone.
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My yield target is now even further out of reach. By considering City analysts’ predictions, the anticipated yield for the trading year to February 2026 is just above 3.8%.
A modest earnings recovery
So I’m locked out of the rising stock and will just have to watch from the sidelines while other investors count their winnings.
But what’s the attraction? My guess is it’s the stability of the supermarket sector and its constant demand. On top of that, Tesco has moved from declining earnings in 2022 and 2023 to modest increases this year and expected ahead.
So there’s been a bit of a recovery in the business, albeit a modest one. Traditionally, supermarkets have been viewed as among the so-called defensive businesses. So when economies and geopolitics are all over the place — as recently — its’s perhaps unsurprising that investors have been buying stocks like Tesco.
I’m not chasing it higher though. One of my concerns is that supermarket margins can be wafer thin. There’s so much competition in the sector and cost pressures keep piling up with the potential to squeeze profits even more.
It wasn’t that many years back that Tesco got into big trouble financially and the share price came crashing down. So much for the defensive nature of the supermarket sector. The problem as I see it is that a similar scenario may one-day play out again.
The directors need to be good
On top of thin profit margins, Tesco is also juggling a chunky debt-load, although it’s running with an interest cover of just above eight, so debt isn’t an immediate concern.
But it could become a problem if shopping at Tesco goes out of fashion with the general public. The low profit margins and high-volume turnover figures mean there’s little margin for error.
One crucial factor for Tesco is that the business needs top-notch management to keep things on an even keel. One slip up in marketing or tactics could easily tip the whole business into lower earnings, as happened before.
Ideally, I want to invest in businesses that have such great economics that any fool can run them. That’s not Tesco.
However, the share price is locked in a strong uptrend and there’s some momentum in the business right now.
So be it. For me, it’s one that got away and I’ll stick to my 5%-yield rule before considering the stock for my portfolio.
