Dividend stocks don’t come much less flashy than Tesco (LSE:TSCO). But for income investors scanning the FTSE 100, that’s not the point.
What matters is whether it’s a good vehicle for long-term passive income. And I think it’s definitely a stock worth keeping on the radar.
Warren Buffett
As far as UK retail is concerned, Tesco is a corporate battleship. It isn’t particularly noted for its agility, but it’s incredibly difficult to stop the thing moving forward.
It must be almost impossible to find a UK adult who hasn’t heard of them. But that might mean investors get tempted to look for something more exciting.
That’s a mistake. As Warren Buffett points out, the fact that Tesco is a really obvious business doesn’t mean it’s a bad investment:
In business, you don’t get any points for the Olympic degree of difficulty. You can win by just doing the simple things well.
That’s not to say that retail is easy – it isn’t. It’s enormously complicated logistically and Tesco’s ability to handle that well is a real strength.
It is, however, to say that the best ideas aren’t always hidden away. And that’s worth remembering for investors looking for passive income.
What are the risks?
Tesco’s industry is about as durable as it gets. But there are always risks in investing and these can’t just be ignored.
A big part of the challenge comes from the fact that there are nearly no switching costs in retail. That means shoppers just go wherever the lowest prices are.
That means increasing prices is risky. But without this ability, the following become more serious potential problems:
- Increased competition as Aldi and Lidl expand their store bases.
- Rising staff costs in the form of a higher minimum wage.
- Consumers spending less as inflation hits household budgets.
The question for investors is whether there are risks with Tesco. It’s whether the company is in a better position to handle them than its rivals.
Tesco’s unique strengths
Despite the challenges, there’s a lot to like about Tesco. One of the company’s key strengths is its Clubcard network, which does a few things.
Clubcard pricing creates an incentive for customers to come back. That’s a big deal in an industry where retention is naturally hard.
The scale of its network means Tesco can sell advertising space on its app. This high-margin revenue provides more scope to compete on price.
It also gives the firm better negotiating power with suppliers. A bigger customer base gives the retailer better bargaining power.
When a company can’t easily charge higher prices, it needs to have lower costs than its competitors. And Tesco’s scale – especially in its Clubcard network – helps it do exactly that.
Passive income
Tesco isn’t an exciting stock, but that is precisely the point. Investors who are looking for explosive growth should probably consider other opportunities.
For dividend investors, however, the story might be different. The dividend yield is 3.07%, but distributions are extremely well-covered by the firm’s earnings.
I think the firm’s unique strengths mean the stock is worth looking at for a passive income portfolio. It might not make a splash, but that doesn’t matter when it comes to investing.
Should you invest £5,000 in Tesco Plc right now?
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Stephen Wright does not own shares in any of the companies mentioned.
