The Motley Fool

Should dividend investors dump these FTSE 100 giants and buy Tesco plc?

In addition to announcing that it would be “merging” with Booker, last week Tesco (LSE: TSCO) also revealed that it would resume paying dividends from next year. The resumption of bi-annual payouts is good news for shareholders on two counts.  

First, study after study has shown that continually receiving and reinvesting dividends is an excellent (if rather unexciting) way of growing wealth over the long term. Although the reinstated payments may be initially modest, every little helps.

Second, the return of its bi-annual payouts suggests that Tesco’s finances are now in considerably better shape than three years ago — a state of affairs that will likely make its stock more attractive to investors. So, in addition to receiving dividends, holders could enjoy a sustained rise in the company’s share price. The fact that Tesco’s shares shot up a full 10% last Friday rather than down (which is the more traditional reaction when an acquisition is announced) suggests market sentiment towards the UK’s biggest retailer has returned in spades.

To be sure, Tesco’s not completely out of the woods yet. Only last Tuesday, it was reported that the company faces a fresh lawsuit from US investment house Manning and Napier over its accounting irregularities, in addition to the legal action instigated by investors against Tesco last October. Moreover, the £16.9bn cap still faces intense competition in the grocery market from listed peers and the German budget supermarkets.  

That said, Tesco looks to be in a far better position than it was a while back, particularly when compared to high-yielding FTSE 100 peers such as Next (LSE: NXT) and Vodafone (LSE: VOD)? So should those investing for income ditch the latter two and snap up the former?

Time to switch?

In sharp contrast to Tesco’s relatively buoyant last month, Next has been going through a torrid time. Claiming the title of ‘biggest loser’ following January’s flurry of retail updates, shares in the £5.7bn cap have continued their downward trajectory after estimating that annual profits would now be at the lower end of expectations. Given that inflation is expected to continue rising and the clothing market is more competitive than ever, I can’t see the shares bouncing back in 2017.

Although times are hard, there’s little doubt that Next remains a decent company, albeit one that has lost its way. A 4.7% yield is appropriate compensation while investors await a recovery. Most importantly, this is covered well over twice by earnings. As such, I’m not sure that those investing for income should move their capital over just yet.

Vodafone, on the other hand, seems to lurch from one crisis to the next. Following last week’s downgrade from Merrill Lynch, the shares now sit 14% lower than this time last year. According to analysts, price wars in both the UK and India mean that the communications giant will report an operating loss in 2017 — its first in a decade.

With returns being “unsustainably low“, Vodafone may soon be pushed into offloading some operations. Even if it chooses not to do this, any re-run of 2016’s Brexit-induced anxiety may leave its forecast earnings growth of 24% in 2018 looking wildly optimistic. While more will be revealed in next week’s trading update, I wouldn’t begrudge investors for moving on. A cut to its 6% yield is certainly possible, particularly as cover is still worryingly low. 

Calling all dividend hunters

If you're looking to generate income from your investments then you'll definitely want to read a special report penned by the experts at the Motley Fool. They think they've uncovered another dividend delight for those willing to look further down the market spectrum.

Click here for your copy of their report. It's completely FREE and without obligation.

Paul Summers has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.